Partnerships for transformation: Using public–private partnerships in the GCC

With the GCC set to spend billions of dollars on development projects, public-private partnerships (PPPs) offer a useful financing and development mechanism. However, to derive the full benefit from PPPs, GCC states will need to adopt a customized approach.

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Partnerships for transformation Using public–private partnerships in the GCC

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Abu Dhabi Samer Bohsali Partner +971-2-699-2400 samer.bohsali @strategyand.pwc.com Beirut Salim Ghazaly Partner +961-1-985-655 salim.ghazaly @strategyand.pwc.com Chucrallah Haddad Partner +961-1-985-655 chucrallah.haddad @strategyand.pwc.com

Dubai Karim Aly Principal +971-4-390-0260 karim.aly @strategyand.pwc.com

Strategy& is a global team of practical strategists committed to helping you seize essential advantage. We do that by working alongside you to solve your toughest problems and helping you capture your greatest opportunities. These are complex and high-stakes undertakings — often game-changing transformations. We bring 100 years of strategy consulting experience and the unrivaled industry and functional capabilities of the PwC network to the task. Whether you’re charting your corporate strategy, transforming a function or business unit, or building critical capabilities, we’ll help you create the value you’re looking for with speed, confidence, and impact. We are a member of the PwC network of firms in 157 countries with more than 195,000 people committed to delivering quality in assurance, tax, and advisory services. Tell us what matters to you and find out more by visiting us at strategyand. pwc.com/me.

This report was originally published by Booz & Company in 2012.

EXECUTIVE SUMMARY

With Gulf Cooperation Council (GCC)1 countries set to spend over half a trillion U.S. dollars on development projects, public–private partnerships (PPPs) offer a potentially useful financing and development mechanism. These development plans seek to increase private-sector participation and to encourage a shift away from GCC economies’ dependence on natural resources. Although they do not work for all sectors, PPPs can ensure efficiency, speed, transparency, and economic impact in the delivery of services or vital infrastructure. To derive the full benefit from PPPs, the GCC states have to take a different approach to that used by either industrialized nations or developing countries. They will also need to ensure that their legal, governance, and supervisory frameworks are fit for the purpose of overseeing this complex and long-term mechanism.
GCC countries need to adopt a rigorous methodology for PPPs by drafting a detailed multisector road map that will pick out PPPappropriate sectors and projects. The road map also gauges the readiness of the private sector to act as the private partner and implement the project. Each GCC country will have to take five sequential steps to draw up its multisector PPP road map: sector selection, sector analysis, project compilation, national project prioritization, and time line development. Governments should follow the road map with an examination of whether a PPP is correct for a specific project based on its affordability, whether lenders will provide financing, and, most important, whether the project offers value for money. The government also needs to be able to monitor PPPs, including handling project execution and procurement. Finally, the government must consider the consequences of the PPP for the budget and government accounting.

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KEY HIGHLIGHTS • GCC countries’ national development programs aim to reduce the size of the government in the economy by expanding the private sector and lessening dependence on hydrocarbon revenues. One method for doing this, if properly implemented, is public–private partnerships. • The GCC needs to use a rigorous, multisector road map methodology that is tailored to its environment and specific development needs. The road map selects appropriate sectors for PPPs and analyses the value chain steps in each sector for PPP opportunities. It helps the government select projects that can find a private partner and that can be implemented in the correct sequence according to economic need. • GCC countries must decide how to allocate risk. In particular, they will need to manage the fiscal consequences of PPPs carefully to avoid long-term budgetary liabilities. Governments also need to build their capabilities to execute and monitor PPP projects.

THE RATIONALE FOR PPPS IN THE GCC

from the ability to draw in privatesector expertise and capital while adjusting the risk to the public purse. However, GCC countries should be careful not to overuse or misuse PPPs. The partnership approach is not right for all projects. The GCC countries’ economic profiles also make PPPs an attractive transformation mechanism. GCC governments want to reduce their natural resource dependence, develop their private sectors, and introduce foreign capital into priority areas. PPPs can advance all of these aims. An additional benefit is that the state retains ultimate control over projects, thereby avoiding some of the pitfalls of privatization. PPPs can also facilitate other aspects of the GCC economic agenda. They can improve national competitiveness by bringing in topnotch foreign companies with transferable skills and best practices. By encouraging legislative and governance changes, PPPs can help create an investment-friendly climate. The GCC can also use PPPs to improve the delivery of such services as education and health. Better-quality education is particularly important, as it will increase the employment of nationals in the private sector.

GCC countries are set to spend well over half a trillion dollars on national development plans in coming years. The main goals of these programs are to promote the growth of the private sector and to encourage a shift in the economic base away from dependence on hydrocarbons. Much of this development spending will be on infrastructure and vital public services, such as health and education. One means of investing this money effectively from fiscal and development perspectives is through PPPs. These are established collaborative mechanisms between the public and private sectors. Countries of all levels of development have successfully used PPPs for over two decades (see “PPP Benefits,” p. 5). Used in a rigorous and targeted manner, PPPs can offer GCC countries an effective means of promoting national development goals. The appeal of PPPs stems

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At the same time, GCC countries’ natural resource endowment makes PPPs a development option rather than a fiscal necessity. More mature economies often choose PPPs as a

financing mechanism when they are strapped for cash. The GCC is in a more favorable position, thanks to trade surpluses and manageable public debt profiles. These countries have

the relative luxury of selecting PPPs that will promote long-term economic development (see Exhibit 1).

Exhibit 1 GCC Countries Have Strong Fiscal and Economic Positions

GDP PER CAPITA, 2010 (IN US$) 76,168 59,717 36,081 38,775 39,171 30,089 33,910 16,996

TRADE SURPLUS, 2010 (PERCENTAGE OF GDP)

40.0% 29.3% 20.7% 3.4% 5.3% 10.0%

Saudi OECD France Germany Kuwait Canada Arabia Average

UAE

Qatar

-2.3%

-1.7% Saudi Arabia Kuwait Qatar

France Canada OECD Germany UAE Average

BUDGET SURPLUS, 2010 (PERCENTAGE OF GDP)

NET PUBLIC DEBT, 2010 (PERCENTAGE OF GDP)

67.4% 21.9% 12.6% Kuwait 16.6% 36.1% 8.6% Qatar Saudi Arabia Qatar Kuwait OECD Average OECD Members GCC Countries 44.4% 51.1% 51.2%

16.4% 6.8% -2.1% UAE

-8.6%

-8.3%

-5.3%

-5.2%

Saudi Canada Germany OECD UAE Arabia Average

France

France OECD Germany Canada Average

Sources: IMF; OECD; Booz & Company analysis

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The use of PPPs in the GCC is set to increase. GCC states are engaged in massive development programs to change their economic structures (see Exhibit 2). • Saudi Arabia began a US$385 billion, five-year development plan in 2010. The plan specifically mentions the use of PPPs. Important objectives include expanding the non-oil private sector, creating employment opportunities for nationals, improving education, and promoting a more equitable distribution of wealth. • Kuwait launched a four-year development plan in 2010 worth

$104 billion. The authorities are looking for the private sector to contribute half of the cost, much of which is earmarked for infrastructure. The goal is to turn Kuwait into a regional trade and financial hub. The country is using PPPs to achieve its objectives. Kuwait has already launched a PPP for a power and desalination plant at Az-Zour North. This independent water and power plant (IWPP) will provide Kuwait with 1500 megawatts of power and 100 million imperial gallons per day of water. • Qatar plans to invest $125 billion between 2011 and 2016 as part of its National Development

Strategy. The government aims to enhance the role of the private sector in the economy, develop Qatari nationals’ skills so that they can meet labor market needs, and reduce inefficiencies in government services. The strategy will launch a portfolio of pilot PPP projects. • The UAE Government Strategy 2011–2013 seeks to encourage the private sector and to improve the skills of the national workforce. Among its priorities are betterquality higher education and healthcare services. The strategy aims to develop an institutional framework for PPPs.

Exhibit 2 GCC Countries Need to Diversify Their Economies

GDP BY SECTOR, AT CURRENT PRICES, 2009 Saudi Arabia Non-Oil Sector Composition: - Government services (16%) - Other services (12%) - Financial institutions (9%) - Construction (5%) - Other (10%) Qatar Non-Oil Sector Composition: - Government services (12%) - Financial institutions (12%) - Manufacturing (8%) - Construction (7%) - Retail (6%) - Transport (6%) - Other (4%)

48%

52%

45%

55%

Kuwait Non-Oil Sector Composition: - Government services (18%) - Financial institutions (14%) - Transport (8%) - Real estate (4%) - Manufacturing (5%) - Other (6%)

UAE Non-Oil Sector Composition: - Trade (16%) - Manufacturing (12%) - Real estate (8%) - Financial institutions (7%) - Construction (7%) - Other (21%) Oil & Gas Non-Oil

29% 71%

45%

55%

Sources: Economist Intelligence Unit; KAMCO Research; Qatar Statistics Authority; Booz & Company analysis

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PPP Benefits Public–private partnerships combine the public and private sectors in projects that the state needs but that private companies can best deliver. Experience shows that the public sector reaps the following benefits from PPPs: • Fiscal benefits: PPPs free public funds for other uses. In the past, the public purse would fund costly infrastructure projects out of revenues or through borrowing. Using the PPP model, that burden shifts to the private-sector partners, which provide substantial equity investment. • Risk allocation: When properly vetted and structured, PPPs allocate risk to the party best suited to handle it. The public sector is often able to shift risks related to lack of demand and revenue, design and construction, operations and maintenance, finance, and extraordinary circumstances to the private sector. • Economic benefits: PPP projects increase efficiency by accelerating the speed of delivery of services and improving service coverage and quality. They also increase time and cost reliability, and attract international and domestic capital. • Technological benefits: PPPs facilitate the transfer of technology and knowhow from the private to the public sector. They improve workforce quality and promote innovation in the public sector. • Social benefits: PPPs improve service coverage, quality, and timeliness. They can also increase living standards, promote environmental sustainability, and mitigate the repercussions associated with privatization.

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KEY CONSIDERATIONS FOR LAUNCHING PPPS

Governments planning to launch PPPs need to consider the legal, governance, and supervisory frameworks within which projects will occur. PPPs can be complex, multigenerational endeavors. They call for substantial commitment from the private sector and close supervision by the government. The legal, governance, and supervisory frameworks therefore provide the public and private partners with defined roles and responsibilities. Legal framework. The success of PPPs as a tool is not determined by having a dedicated legal framework. Similarly, the lack of specific legislation does not stop the use of PPPs. The countries that tend to manage without PPP laws are those with friendly business environments or well-established bodies of commercial law. The United Kingdom, for example, is a frequent user of PPPs, but has not put in place a dedicated PPP law. Instead,

the legal issues arising from PPP projects are handled through existing commercial codes. Other countries pass legislation to enable specific elements of the PPP process. This can include allowing the transfer of public land to private investors, or putting in place safeguards to reassure investors. Countries considering such partnerships should bear in mind that PPPs can involve legally complex aspects, such as the reversion of assets back to the state, provisions that may not be covered by existing laws. In the GCC, only Kuwait has a well-established PPP framework of legislation (Law No. 7/2008), governance, and execution structures. Until recently, other GCC countries managed with a case-by-case approach. In Saudi Arabia, for example, the respective public entity in the economic sector manages the PPP project in coordination with the private partner. There is no legislation or supervisory entity. The UAE has

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similarly managed without PPP laws, although Dubai is now considering its own PPP legislation. Qatar is also developing a PPP law and is planning a governance framework for PPPs under the auspices of the Ministry of Business and Trade. There will also be dedicated PPP program units within relevant government agencies. Governance framework. Another important consideration is the governance framework, which monitors the overall performance of PPP projects. Governance, like legislation, aims at fairness and balance. It provides checks and balances for the government and the private providers. Independent regulatory agencies provide governance. Their independence ensures freedom from political manipulation. At the same time, their regulatory function allows them to hold private investors accountable to deliver their side of the bargain.

These independent regulatory agencies can cover either specific sectors or all PPPs. These agencies need to examine overall performance, including tariffs and quality. In India, for example, the Comptroller and Auditor General has drawn up auditing guidelines for PPPs. The Comptroller and Auditor General is an independent official who reports to parliament and who recently started to audit individual PPP projects. Supervisory framework. The supervisory framework’s role is to carry out PPP projects on a daily basis. Although PPPs are longterm agreements, they still require government and the private sector to maintain regular liaison. For the government this involves monitoring implementation. For the private sector, this provides a mechanism to rapidly identify problems and have them officially addressed.

The supervisory framework’s main feature is a unit dedicated to overseeing PPPs. Although individual ministries may choose to establish their own PPP offices, countries that have limited resources or are still unfamiliar with the PPP project cycle will benefit from a central bureau that will capture knowledge from across the government. Such an entity ensures that procedures and execution principles continue from one project to the next, thereby institutionalizing consistency. The supervisory framework needs to elaborate appropriate procedures for each phase of the actual PPP project cycle. PPPs proceed through four phases: project assessment, detailed preparation, procurement, and project implementation. All of these stages, however, come into play only after the government has developed a road map that identifies precisely what projects are needed and when.

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DEVELOPING A MULTISECTOR ROAD MAP

similar fashion, the road map will alert investors to the government’s objectives and allow them to mobilize for upcoming projects. The road map is a top-down analysis that breaks down the economy into sectors, points to projects suitable for PPPs within these sectors, and then filters them according to priorities, before finally plotting them on a schedule. Road map development has five phases (see Exhibit 3): 1. Sector selection: Determine PPPappropriate sectors. 2. Sector analysis: Examine each sector to identify priority PPP projects using five criteria of value chain readiness. Each value chain

step is subjected to an external and internal assessment to determine PPP potential. 3. Project compilation: Assemble all potential projects into a national registry, or “long list.” 4. National project prioritization: Rank projects by priorities in all selected sectors using five privatesector and three government criteria. This generates the road map and vets the capability of the potential private partners, judging their readiness for PPPs by examining their experience and exposure to the region. 5. Time line development: Create a detailed schedule for priority projects identified in phase 4.

For the GCC countries, the most important step in using PPPs is to develop a multisector road map. The road map connects PPPs to national developments goals. The GCC states need to use this rigorous methodology because it identifies where PPPs are most likely to succeed. The road map also helps GCC governments focus their limited specialized expertise in this area on high-impact projects. In a

Exhibit 3 Multisector Road Map Development Phases

1

2

3 PROJECT COMPILATION

4 NATIONAL PROJECT PRIORITIZATION

5 TIME LINE DEVELOPMENT

SECTOR SELECTION

SECTOR ANALYSIS

Source: Booz & Company

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Sector Selection Governments have to decide which economic sectors would benefit from PPPs (see Exhibit 4). For this, governments must answer two questions. The first is how willing the public sector is to reduce its control over a particular activity. This will exclude areas of strategic importance, such as defense. The second question relates to the role of each sector in the national development plan. For GCC countries, this may exclude oil and gas, as this industry does not lack investment and is already overly dominant in the economy. Sector Analysis Finding opportunities inside a sector requires analyzing its value chain. Sector analysis identifies priority PPP projects using five key criteria

of value chain readiness. The methodology then scrutinizes each value chain step through external and internal assessments that determine PPP potential. Value chain readiness. Governments should use five objective criteria to evaluate each value chain step’s readiness for PPPs: 1. Scale and long-term nature: Does the value chain step require major capital investment and service delivery over a long time frame? 2. Clearly defined service needs: Does the value chain step allow the public sector to define its service needs as outputs that can be written into the PPP agreement? Can the contract ensure effective and accountable

delivery of services over the long run and unambiguous payment schedules to the private partners? 3. Clear risk allocation: Does the value chain step allow for the clear identification and allocation of risk between the public and private sectors? 4. Well-defined costs: Does the value chain step allow for a whole life cost estimate for providing a project’s assets and services? Whole life cost analysis includes the price of operating and maintaining a facility, in addition to initial capital costs. 5. Stable requirements: Is the value chain step reasonably stable and not susceptible to short-term or sudden changes in design or technology?

Exhibit 4 Drawing Up the Multisector Road Map: Sector Selection

SECTOR LONG LIST Sector 1 Sector 2 Sectors selected to increase private-sector participation Sector 3 Sector 4 Sector 5 Sector 6 Sector 7 Sectors that can increase non-oil GDP Sector 8 .... Sector n No Sector 2 Sector 2 is critical to national security and should stay in the public sector No Sector 5 Sector 5 was excluded as it is overly dominant and does not need investment Yes Yes Is the public sector willing to reduce its control? Does the sector play a role in the national development plan?

PRIORITY SECTORS FOR PPP PROJECTS

1 2 3 4 5 6 7 8

Sector 1 Sector 3 Sector 4 Sector 6 Sector 7 Sector 8 .... Sector n

or

Source: Booz & Company

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The power sector provides an example of this methodology in action. Power has three value chain steps: generation, transmission, and distribution. The step most amenable to PPPs is generation, because of its: 1. Scale and long-term nature. Generation projects involve building and operating plants. Projects need long durations and require large-scale capital expenditure. 2. Clearly defined service needs. Outputs are easily identifiable (e.g., megawatts of electricity). 3. Clear risk allocation. Projects are usually plants confined to one location run by the private investor, which usually bears the design and construction risks, while often the government bears partial demand risk because it is the off taker (initial buyer). 4. Well-defined costs. Costs usually consist of capital expenditures and operating expenditures. They can be easily estimated based on similar projects. 5. Stable requirements. Generation plants generally require few unplanned upgrades and expansions over their lifetime.

External assessment. Following the analysis of value chain readiness, an external assessment evaluates the “readiness” for PPPs of each part of the value chain based on lessons learned from international benchmarks. International benchmarks yield two forms of guidance. First, they allow the authorities to see which value chain steps are most frequently structured as PPPs internationally. Second, they inform a government about relevant PPP models used abroad, such as service contracts, management contracts, build-operate-transfer contracts, and the like. Studies of the power sector in the United Kingdom, Italy, and Australia confirm that generation is the most PPP-friendly value chain step. The main models are build-operate-transfer, whether as IWPPs or independent power projects (IPPs). The first British partnership in generation was the IPP at Corby. ESBI, an Irish state-owned company, launched a 350 megawatt gas-fired power station in 1992. Internal assessment. The value chain steps identified by the external assessment then undergo an internal assessment. This prevents a government from copying mature country models that may not work in its national development context.

The internal assessment uses three country-specific criteria to winnow the results of the external assessment: • Demand and supply: Assesses the need for a project based on the gap between demand and supply, such as electricity production versus consumption needs. • Government capabilities and legal structure: Checks that the government is able to carry out PPPs by examining its project oversight experience, and reviews local laws for possible constraints on project execution. • Private-sector capacity: Evaluates whether private partners with relevant experience exist for the project under consideration. Project Compilation This rigorous sector analysis allows the government to compile a national registry of potential projects—the long list. By examining each value chain step in this comprehensive manner, the government is able to decide whether or not a project should be considered for the final road map, while simultaneously ensuring comprehensive coverage of the economy and alignment with national development plan objectives.

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National Project Prioritization The long list of projects is ranked according to private- and publicsector priorities. The ranking uses five private-sector and three government criteria (see Exhibit 5). Officials can assign weights to each of these criteria as is necessary for their country’s particular circumstances. This step of the methodology assembles the road map and vets the capability of the potential private partners by judging their readiness for PPPs. The private-sector criteria evaluate the attractiveness of projects to private partners: 1. Private-sector availability: Are there private players, whether international or regional, with the relevant experience to conduct the project? For example, have they implemented a similar project in the region before? 2. Size of demand: How large is the demand for this project? For

example, what is the extent of the gap between demand and currently available supply? 3. Urgency: How urgent is the demand for the project? For example, does the project need to be completed before other items on the long list of projects? 4. Ease of implementation: How complex is the project? For example, does the project require advanced technology? Does the project require coordination with a public entity, and does that entity have the technical, legal, and financial capabilities to monitor the project? 5. Revenue source: Is the project going to be reliant on government subsidies to break even or is it going to rely on user charges or government purchase agreements? Government-sector criteria evaluate the project’s socioeconomic benefits:

1. Impact on private-sector employment: How many individuals will this project employ? 2. Impact on GDP: How much will the project contribute to GDP? 3. Impact on competitiveness: Will the project improve national competitiveness? For example, what impact will the project have on the country’s ranking in the World Economic Forum’s Global Competitiveness indices? Time Line Development Once projects have passed through the national project prioritization filters, the government can lay out the PPP road map in terms of timing. Decision makers are in a position to select top priority projects and to schedule their implementation using realistic time frames that accommodate the government’s implementation capabilities.

Exhibit 5 Drawing Up the Multisector Road Map: National Project Prioritization
NATIONAL REGISTRY OF POTENTIAL PROJECTS Project Long List - Project a - Project b - Project c ....

PROJECTS RANKED ACCORDING TO PRIVATEAND GOVERNMENTSECTOR CRITERIA Prioritized List of Projects 1- Project c Prioritization Criteria Private-Sector Criteria Private-sector availability Size of demand Urgency Ease of implementation Revenue source + Government-Sector Criteria Impact on private-sector employment Impact on GDP Impact on competitiveness 2- Project a 3- Project b 45678910....

-

29-

Source: Booz & Company

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PROCEED WITH CAUTION

GCC governments need to proceed with caution when implementing the road map. Although the road map helps a government know which projects it should actively consider, it cannot tell the government how to manage these projects. Nor does it show how the government’s accounts should handle the complex, long-term liabilities that may arise from PPPs. Is a PPP the Correct Approach? The government should use three criteria to assess whether a PPP is the correct approach for a given project. These criteria provide a final check on the project side before the government then turns to examine its own capabilities. They are: affordability, bankability, and value for money. Affordability relates to the capacity of the end-users or the public sector to pay for the building, operation,

and maintenance of the project. Much depends on how the PPP will earn its revenues. If the PPP charges consumers, then their capacity and willingness to pay is an important factor. This is especially relevant if prices, such as for electricity, increase. Rising utilities tariffs could also have broader economic effects. The government must also take into account the effect on the budget if the PPP will rely either on government subsidies or on government purchase agreements. Bankability determines whether lenders are willing to finance the PPP. Financial institutions consider the anticipated cash flow of the project as the principal source of security. This obliges the government to assess financial risks thoroughly.

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Value for money requires a costbenefit analysis as to whether the project costs less than the best realistic public-sector alternative. The alternative project from the public sector is known as the “public-sector comparator.” This method weighs the greater efficiency of the PPP against factors that make it more costly, such as bidding, contracting, and financing. In general, PPPs are likely to provide value for money if some of the following conditions are met: they are implemented by capable privatesector partners; risk is clearly allocated between the public and private sectors; and the public sector defines its service needs as outputs in the contract. Building Government Capabilities Governments need to build their capabilities to manage PPPs. The

careful approach of the road map will assist them. The road map demands that the government examine its capacity to handle PPPs during sector analysis when it undertakes the internal assessment. One of the most important capabilities relates to managing the project cycle, perhaps the most testing aspect of PPP deployment. There are four project steps in this cycle that require government agencies to have a spectrum of capabilities: project assessment, detailed preparation, procurement, and project implementation. Project assessment ensures value for money. Detailed preparation solicits a healthy range of competitive bids. Procurement ensures the best private-sector partner is anchored to the project with an enforceable contract, financing, and ancillary agreements. Project

implementation involves managing project delivery and assessment. This can include replacing non-performing parties. At the end of the contract, the supervisory body has to measure the residual value of PPP assets and provide a post-project evaluation. In the GCC, Kuwait set up the Partnerships Technical Bureau (PTB) to manage PPPs as part of Law No. 7/2008. The PTB develops project concepts, vets proposals, conducts pre-feasibility studies, selects transaction advisors, manages feasibility studies and the procurement process, arranges final awards, and creates the required special purpose vehicles for the projects. The public-sector employees staffing these agencies need to acquire the correct skill sets. They must understand the PPP law, its

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definitions, and its procedures. They may also have to change their outlook from that of project execution to project planning and oversight. A good example of a body with these capabilities was Partnerships UK, which functioned from 2000 until 2011. Jointly owned by the private sector and the government, Partnerships UK created specialist arms for PPPs in relevant ministries, such as education and health. Partnerships UK was largely staffed by the private sector. It also provided advice and knowledge sharing for all parts of the government, from national to local level, that wanted to launch PPPs. The organization has been replaced at the national

level by Infrastructure UK and at the local government level by Local Partnerships. In Australia, Victoria State’s supervisory body is Partnerships Victoria. The organization provides support and management of PPP procedures and practices. Partnerships Victoria sits within the Commercial Division of the state’s Department of Treasury and Finance. Fiscal Impact A final concern for governments is how to record the long-term fiscal liabilities from PPPs. The two main fiscal accounting approaches are cash and accrual. The EU provides one example of how governments

that use accrual accounting can deal with the fiscal effects of PPPs (see “How the EU Accounts for PPPs,” p. 15). However, most governments in the Middle East still use cash accounting. A particular danger for governments with cash accounting systems is that they lack formal mechanisms to capitalize and record the long-term liabilities from PPPs. Governments using cash accounting can make the mistake of treating PPPs as off-balance-sheet debt, which conveniently shows improved budget deficit and debt figures. These improvements are, however, illusory. They do not accurately reflect a government’s fiscal position or public net worth.

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How the EU Accounts for PPPs One method for grappling with the fiscal impact of PPPs for countries with accrual accounting comes from the European System of Accounts (known as ESA95). This requires statisticians to look at the risk/reward balance in the underlying PPP arrangement. ESA95 analyzes the allocation of construction, availability, and demand risk. Construction risk covers events related to the construction and completion of the PPP’s assets. Availability risk refers to situations in which underperformance linked to the state of PPP assets results in partial or complete denial of services during the operational phase. Demand risk relates to the variability of demand irrespective of the private firm’s performance. According to ESA95 rules, if the government bears the construction risk, then the PPP project is on its balance sheet. This is irrespective of the allocation of demand and availability risks. ESA95 also states that if the government takes on the demand and availability risks, then that also places the project on its balance sheet. The only way ESA95 allows the government to classify the PPP as off its balance sheet is when it absorbs just one risk—either demand or availability.

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CONCLUSION

GCC countries can use PPPs effectively as part of their ambitious national development programs if they adopt the road map method. PPPs are not a panacea. They are not the answer to every development problem, nor to every infrastructure need. GCC governments should move cautiously. The environment in the GCC is quite unlike that of industrialized and developing countries that are using PPPs. So although some international

comparisons are helpful, the GCC needs a customized approach. The road map provides the necessary tailor-made, powerful tool that will enable GCC countries to pinpoint which economic sectors will benefit from a PPP. GCC governments will have to supplement the road map with assessments of the financial viability and fiscal impact of PPP projects, while building the public sector’s planning and oversight capabilities.

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Endnotes
The GCC consists of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates.
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Strategy& is a global team of practical strategists committed to helping you seize essential advantage. We do that by working alongside you to solve your toughest problems and helping you capture your greatest opportunities.

These are complex and high-stakes undertakings — often game-changing transformations. We bring 100 years of strategy consulting experience and the unrivaled industry and functional capabilities of the PwC network to the task. Whether you’re charting your

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We are a member of the PwC network of firms in 157 countries with more than 195,000 people committed to delivering quality in assurance, tax, and advisory services. Tell us what matters to you and find out more by visiting us at strategyand.pwc.com/me.

This report was originally published by Booz & Company in 2012.

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