Another COVID-19 Challenge: Saving Asia’s Crucial Infrastructure Deals
The public-private partnerships used to finance roads, ports, hospitals and dozens of other infrastructure projects could be affected by the pandemic-induced financial crisis. Here’s how to avoid that.
The economic downturn caused by COVID-19 is the greatest economic calamity since the Great Depression and is disrupting the construction, operation and maintenance of infrastructure services globally. Throughout Asia and the Pacific, this could cause serious delays in the construction of roads, schools, hospitals, ports, airports, and other critical pieces of infrastructure financed by public-private partnerships (PPPs).
Avoiding worst-case scenarios will likely require good use of contract renegotiation, and other contractual adjustment mechanisms and insurance provisions, in order to achieve the intended development outcomes. Governments and private contractors will benefit from understanding good policy and practices for conducting these negotiations.
As a first step, governments will need to assess impacts on the financial viability and sustainability of planned and ongoing public-private partnership projects and be prepared to manage the contractual impacts. These however will be difficult to predict and will be highly specific from project-to-project and country-to-country.
This may affect the contractor’s ability to achieve construction milestones, obtain supplies, transport materials, and result in custom and importation delays among a myriad of other contract compliance and administration matters. Take-or-pay contracts that are common in the energy sector will likely be affected. These contracts require a buyer, such as government ministry or state-owned enterprise, to take a specified amount of product or pay the seller a penalty. In essence, governments may be contractually obligated to pay even if demand reduces due to COVID-19 and regardless of whether or not it actually takes delivery.
The unavailability of government staff due to quarantine procedures can result in an inability to respond to requests from project companies. Failure to grant approvals, carry out on-site supervision or testing could result in a breach of contract. Governments may prioritize construction projects near completion or healthcare projects, such as construction of a hospital, that will combat the effects of the pandemic. If a government prioritizes certain projects it still must ensure compliance with its contractual obligations under the other projects, such as those deemed a lower priority.
Public-private partnerships are usually structured so the demand risk is retained by the project company through user fees, or where the project company receives availability payments from government for delivering a service. In demand risk-based PPP projects, declining demand could impact project cash flows, or trigger minimum revenue guarantees offered by government in toll roads.
Here’s how we can protect the PPPs that help finance Asia’s infrastructure
Governments are already feeling fiscal pressure due to the pandemic that has created liquidity problems, and these payment risks may also affect the debt service obligations of the PPP companies. In some cases, where prolonged non-availability or significant payment delays happen, that may trigger project contracts to be terminated thus potentially causing a large termination payment obligation on the government, at a time when government can least afford this due to rising social and health expenditures.
In any event, the government and the PPP company have to first find solutions within the ambit of the contract. Possible contractual impacts for governments and private sector partners include declaration of force majeure and contractual protections and remedies resulting from force majeure, construction delays and failure to meet milestones, other default events, and performance bonds being called. Such events require that governments carefully consider and solicit legal and commercial advice on the best course of action to take.
Renegotiation refers to changes in the contractual provisions of a PPP contract, when these changes are negotiated between a project company and the government outside rather than through the adjustment mechanisms contemplated in the contract. Renegotiation is already a fraught issue in many jurisdictions and poses a challenge to the overall value for money for projects if not carried out transparently.
If the projects are not properly reviewed and audited, public-private partnerships can be vulnerable to corruption leading to inappropriate renegotiation particularly in the absence of fiscal transparency, public policies supportive of disclosure of project information, and budgeting for and disclosure of additional expenditures due to renegotiations.
While renegotiation should be avoided if possible, it is likely that due to the long-term time frame of PPP contracts, or due to a crisis such as COVID-19, some renegotiations and contract adjustments will be inevitable – and quite likely require a recalibrating of availability payments, revising contract requirements and standards including scope changes where necessary, possible extension of terms, and putting in place additional financing facilities in order to continue the project procurement or project delivery.
Governments however should seek to maintain an open dialogue with the various contractual partners throughout the crisis to avoid reputational damage to any of the parties and looking towards a constructive commitment to continue operations
Global infrastructure investments are already known to have fallen short of levels required to support social and economic development goals in emerging markets and developing economies. Moreover, fiscal risk management systems in many developing countries may not be prepared to manage the impacts of this unprecedented crisis without support and financing from the international community.
The pandemic can only exacerbate this situation. Past economic crises have demonstrated that infrastructure investment is not the best way to kickstart an economy. But it can provide long-term sustainable growth when combined with government capacity to assess fiscal impact, design risk transfer between the public and private partners, and ensure transparency of PPP expenditures including additional spending related to a renegotiation.
The world is likely to face such events in the future, whether caused by a pandemic, climate-related disaster, or a financial crisis. Learning from this experience will help governments improve upon existing force majeure and compensation clauses in PPP contracts to ensure that infrastructure is resilient and sustainable.