LINDA NOBAZA: Public-private partnerships might not be the answer to SA’s woes

SA’s triple challenge is unemployment, poverty and inequality. Unemployment is at a record high, with youth joblessness above 60%. We are the most unequal society in the world. It therefore makes sense that public policy choices be appraised against their effect on this triple challenge.

In economics it is generally accepted that infrastructure investment is the backbone of development and economic growth. SA’s capital formation has been on a declining path for the past decade. To reverse this, the government is looking to public-private partnerships (PPP) to improve public sector infrastructure investment.

It will not be the first time the government has used PPPs to fund public infrastructure. The Gautrain, Chapman’s Peak tollway and various SA National Roads Agency toll roads are examples of existing PPP projects.

The 2022 budget statement defined PPPs as “a contract between a public sector institution and a private party, where the private party performs a function that is usually provided by the public sector and/or uses state property by agreement”.

PPPs can be considered a special form of government bond. Instead of the government receiving cash for its bond, it receives a tangible asset such as a hospital or railway. The total cost of building the asset enters the liability side of the national accounts. Unlike typical government bonds, interest and capital are repaid by the users, but guaranteed by the government.

Typically, a special purpose vehicle (SPV) is incorporated as a joint venture between a public institution and private entities that may include financial institutions. It is the SPV that has the responsibility to raise funds, build, operate and hand the asset over to the government after a predetermined period.

Normally the SPV signs “take or pay” agreements with the government or a state-owned enterprise (SOE), depending on the type of asset the SPV is going to build and operate. In the case of an SOE, it signs back-to-back take or pay contracts with its customers and the SPV. In effect, it is the SOE’s customers who take the demand risk, thereby guaranteeing debt repayments and the required returns of the SPV.

In the case of a direct government asset such as the Gautrain and e-tolls, the government takes on the demand risk directly. Through the “user pays” principle, users are expected to cover debt repayments and the required returns of the SPV. However, if there are not enough users, such as occurred with the Gautrain, the government is required to make up the shortfall.

Public revolt against the user pays principle, like the scenario that occurred with e-tolls in Gauteng, is the worst-case scenario for the government because it becomes the primary party responsible for both debt repayments and the required returns of the SPV.

In other words, SOE customers or end users of a public good can be considered the parties that issue the bond on behalf of the government and are responsible for debt repayments. This would be equivalent to a form of tax paid only by users. Given that public goods have inherently positive knock-on effects, these users would be subsidising others who benefit indirectly.

A typical example could be when the availability of railway capacity funded through a PPP and paid for by Transnet customers through back-to-back take-or-pay contracts facilitates and attracts mining exploration.

Through take-or pay-agreements, the viability of the SPV is guaranteed. PPPs turn the capital asset pricing model (CAPM) on its head. Equity holders of the SPV lock in risk-free equity returns over the entire agreement period. Debt funders lend to the government via the SPV at higher yields than the bond market.   

It must be noted that both equity and debt holders do not take any more risk than in an alternative private asset. In fact, the reverse is true. In a private sector asset build, equity and debt holders carry all the risks of asset delivery and demand. This makes PPPs attractive to private capital.

PPPs are generally motivated as public sector funding mechanisms that can transfer most of the project risks to the private sector. These risks are technical, financial and operational, such as cost escalations and budget overruns. However, the challenge is that the private sector has a near monopoly of skills in contracting and risk allocation, and in most cases the government ends up carrying most of the risk.

A case in point: according to Railways Africa, “the initial estimate of the cost to build the Gautrain was R7bn, and this was the figure used to conduct feasibility studies and cost benefit analyses for the project”. However, the total costs escalated to over R30bn, with more than R27bn paid by the government.

Furthermore, the total cost of a PPP project becomes a contingent liability to the government, but repayments of this debt are carried by end users, not the fiscus. This is considered an advantage because the fiscus is spared the debt repayments. However, this is not guaranteed, as we have seen with the Gauteng government paying R1.5bn in 2018 to the Gautrain SPV because of declining user numbers.

PPPs turn out to be a more expensive funding mechanism than typical government bonds. Cost of capital is high because PPPs use a project finance funding model. In project finance, funding is provided on the strength of future cash flows. Due to high risk embedded in estimating future cash flows, risk premiums over the cost of debt and equity are usually high. However, this seems to be at odds with the fact that the government ultimately underwrites the whole project’s potential losses.

Due to the high cost of capital, user charges are usually also high, limiting access to a public good to the rich. For example, the Gauteng government has thrown billions at the Gautrain to compensate for the lack of users, yet many ordinary citizens travelling between Johannesburg and Pretoria cannot access the Gautrain because of high fares.

In the case of Transnet and Eskom, PPPs are unlikely to reduce the cost of doing business. Given that SOEs carry debt as a contingent liability on their balance sheets, higher risk premiums — a constant feature of PPP projects — will increase the cost of capital. In fact, Eskom and Transnet are already at the upper limit of debt ratio covenants. Thus, the risk of higher cost of capital would permeate across the system, put pressure on SOEs’ balance sheets and consequently increase tariffs.

This leaves SA with just one significant motivation in favour of PPPs — to reduce the risk of sovereign debt by reducing growth of interest payments in the national budget while increasing contingent liabilities. However, stagnation generally leads to an increase in the debt-to-GDP ratio, and consequently interest payments would rise as a percentage of the national budget.

Unemployment, poverty and inequality are the dominant risks to the future sustainability of our country. Thus, any supposed benefit that fails to solve this triple challenge is not worthy to be considered in the public policy choice equation.

• Nobaza, a financial modelling professional with Anglo American, formerly worked for the National Treasury and Telkom. He writes in his personal capacity.