In our previous thought leadership, we explored why developing economies in Africa should tap into private sector and sovereign funds to finance their Nationally Determined Contributions (NDCs). Development of climate resilient infrastructure will play a key role in climate risks mitigation and adaptation going into the future; hence there is a need to widen the sources of funding for the same. Public Private Partnerships (PPPs) are being championed as a preferred financing model for infrastructure investment in Africa; but the adoption of PPPs has been low.
By design, a PPP is structured as a Special Purpose Vehicle (SPV) that owns assets and carries its own liabilities independently from its parent companies. The SPV legal structure helps the public and private parties involved in the PPP project to safeguard their assets in the parent organizations as they undertake riskier projects together. On the other hand, the off-balance sheet accounting for PPPs helps the parties involved to easily raise funding for the project without being limited by the parent organizations’ liabilities and capital structures. This legal separation of the SPV undertaking a PPP project from its parent organization is the central stem from which all other characteristics of a PPP branch out.
In a typical PPP infrastructure project, the public sector party provides the land and other resources needed to undertake the project; while the private sector player provides the technical expertise as well as the financing needed. The private sector player then develops the project and maintains the infrastructure over an agreed period of time before handing it over to the public sector party in the PPP. Over the project lifetime, the private sector party collects money from the users of the infrastructure or it gets direct payments from the public sector party; in order to recoup its principal investment and a reasonable profit margin on top.
One of the reasons why PPPs have not been mainstreamed in most African economies is because they are a fairly new concept across Africa. However, the concept is slowly being appreciated as successful PPP projects emerge in the continent. In addition, there are few PPP practitioners across the continent to provide professional support to governments and private sector players in designing and delivering sustainable PPP projects. On the other hand, corruption within governments is often quoted as a hindrance for private sector players who would like to invest in infrastructure projects in Africa through the PPP model.
Private sector players interested in investing in PPPs in Africa also cite lack of a bankable pipeline to invest in; as a one of the leading limitations to them deploying capital in the continent. Lack of proper control of the projects once they are completed due to political interference also makes private sector investors hesitant to take on PPP projects with local African governments. This second factor is tied to instability in the local regulatory environments; whereby change in government leadership leads to overhaul of policies which may negatively impact ongoing PPP projects. Security guarantee for PPP investments over their lifecycles and the returns thereof are a critical factor for private sector investors; hence, when threatened by political and regulatory instability, the investors opt out of the African economies.
High transaction costs and low risk adjusted returns also hinder private sector investors from taking on PPP projects in Africa. PPP projects involve transaction advisors, lawyers and other professionals who provide technical support to the projects. The fees to all these professionals may go as high as 10% of the project cost, hence inflating project expenses before cost of capital is included. Ultimately, these high transaction costs reduce the overall project returns to the private sector investors.
The above challenges notwithstanding, the shrinking of development funding from developed economies is forcing governments in Africa to pursue the PPP route in order to finance their infrastructure projects across the continent. A deep understanding of the PPP financing model is therefore required by both the private sector and the public sector players; in order to ensure value for money is achieved in all PPP projects being undertaken.
Author: Jeremy Riro