Introspective
Business World
THERE ARE BETS you’d rather lose. My good friend former socioeconomic planning secretary Ciel Habito and I have a running bet on the GDP growth for this year. His is optimistic at 7% and mine is conservative at just above 6% forecast. With the release of the third-quarter GDP growth at 5.3% last Thursday, it looks like I have a “free” lunch, care of Ciel.
We may disagree on our numbers, but Ciel and I both see that the key to
higher growth lies in the government getting its act together. The
government has much to do in terms of relieving infrastructure
constraints to drive economic growth both in the short and long term.
Short-term growth would be propelled by government spending for
infrastructure and by construction of public-private partnership
projects, long-term growth by the resulting improvement of connectivity
and efficiency in the market attracting private investments that would
create jobs and generate economic activity.
However, last quarter’s GDP growth dipped anew, dragged down by low
government spending especially for infrastructure and by the poor state
of road transport and seaports. It seems that the government is not
doing enough to straighten out its troubles.
Back in July this year, we at GlobalSource wrote that “the setback
caused by the Supreme Court decision on public spending as well as the
slowness in decongesting the Port of Manila threatens 3Q14 economic
growth” and proceeded to pare our 2014 GDP growth forecast to 5.8%. When
August data showed better-than-expected second-quarter growth, we said
that “the economy is not yet out of the woods in terms of bearing the
costs of port congestion, which will feed into prices and economic
activity in 2H14” but conceded a return to our start of the year 6.1%
forecast.
And indeed third-quarter growth, reported at 5.3%, is way below the
6%-6.5% figures from journalists’ polls. Apart from government
underspending (consumption and construction fell 2.5% and 6.2%
respectively) and the seven-month-long gridlock at the main
international seaport in Manila (despite its growth-boosting impact via
weak imports, it may have also caused lower inventory buildup and on the
supply side, an evident slowdown in transport and storage services), a
mix of higher inflation and lower peso remittance growth saw household
spending slowing down (to 5.2% in the third quarter from a revised 5.7%
in the second quarter and 5.9% in the first quarter). At the same time,
bad weather led to a 2.7% decline in agriculture, which is about 10% of
GDP.
The much lower third quarter performance brought year-to-date GDP growth
to 5.8%. With fourth quarter economic activity typically supported by
Christmas festivities and upbeat consumer and business sentiments, what
is the likelihood of fourth-quarter GDP reaching the 6.8% needed to
achieve our latest 2014 forecast?
There is good news. Inflation is decelerating, port cargo movement has
reportedly improved with the lifting of the local government’s truck
ban, private construction shows momentum (12.7% in the second quarter
and 15.7% in the third quarter), and despite the reported recession in
Japan and slowdown in China, exports to these two major trade partners
show robust growth (20% and 22% in nominal dollars, respectively, from
January to September).
On the other hand, we continue to wrestle with the question of whether
or not government can deliver on its promised spending. During the
pre-DAP (Disbursement Acceleration Program), high growth periods, public
sector consumption and construction together contributed anywhere from
one to almost three percentage points of quarterly GDP growth. Hence, if
government officials are rightly optimistic about rehabilitation
spending gaining traction, a high fourth-quarter GDP growth is feasible.
But how likely is it?
Part of this column was culled from a recent GlobalSource report written
by Christine Tang and Romeo Bernardo. Mr. Bernardo is Philippine
GlobalSource advisor and is a board director of IDEA.
Sunday, November 30, 2014
Sunday, November 2, 2014
The PPP promise, a work in progress
BUSINESS WORLD
Introspective
After a false start and a few years limping along, the Aquino government’s flagship PPP program finally roared to life. In relatively quick succession, the government bid out or awarded four projects worth P125 billion and rolled out six more costing about P170 billion. What was particularly surprising was that the auctions yielded substantial concession fee payments to the government, as against pre-bid financial model results showing that the government would have to provide subsidies to enhance project cash flows.
Encouraged by the successes, the government through the PPP Center has lined up another seven projects worth about P180 billion for approval by the National Economic and Development Authority (NEDA) board, and is preparing feasibility studies for 10 other projects. In all, there are about 50 projects in the PPP Center’s pipeline which the government is also actively marketing to foreign investors through a series of international road shows.
The mood has not always been this upbeat due largely to unmet expectations following the government’s high publicity launch of the program back in 2010. Then, the much-hyped “PPP is the solution to the infrastructure shortage in the country” failed to consider that in the wake of controversies surrounding failed PPPs in the past, both sides of the partnerships had their guard up and were distrustful of each other. In particular in the aftermath of the Asian crisis, the public sector had to grapple with and absorb some of the liabilities in PPP contracts, and for years leading up to 2010 preferred to manage the risks from contingent liabilities by avoiding them altogether. In turn, the private sector was particularly leery of government contract promises that the latter had time and again failed to keep, notably delays in tariff adjustments in most sectors -- power, water, rail, toll roads -- particularly during politically sensitive periods.
Moreover, there were very few market-ready projects in the pipeline at the time and fast-tracking last-mile adjustments to ready projects was constrained by technical limitations in implementing agencies. It was thus a slow process of learning by doing on a per-project basis, tentatively delineating risks among the parties involved, with the government deftly testing what risks the market could bear through actual biddings of smaller projects.
These included (a) a small 4-kilometer (km) toll road in December 2011 that very soon became stuck in right-of-way (ROW) disputes, and (b) a project to build classrooms, awarded in September 2012, that was the first of its kind in that it relied solely on government payments for its cash flows and thus was not able to attract more bidders willing to assume congressional appropriations risk. Critics also pointed out that this project and its second phase the following year lacked features of true PPPs in that the private sector merely handled construction of the schools and were not exposed to market and operating risks.
The first major win for the Aquino government was the P15.5-billion, 7.75-km, four-lane elevated NAIA Expressway project that had been in the drawing board for decades and was finally brought to market with donor technical assistance. Albeit it attracted only two bidders, the auction, won by a consortium led by one of the large domestic conglomerates (SMC) in May 2013, yielded P11 billion in concession fees to the government and by early 2014 had already broken ground. Another win six months later was a five-way bid in November to install a P1.7-billion single-ticketing system for Metro Manila’s rail system, where the winning bid was a P1.1-billion payment to the government.
But it has not become easier. The latest auctions, involving three multibillion-peso transport projects, have been uphill struggles for both the government and the private sector. The challenges that have emerged during the bid stage are reminders of the inherent difficulty and associated time lag of doing PPPs, especially in a developing country like the Philippines where institutions remain weak and bidders take for granted that calling on the courts, Congress or the President to intervene on their behalf is part of the rules of the game. Such politicization of the formal PPP processes tarnishes the program’s image and dulls investors’ appetites. Here are a few of the project holdups:
LRT LINE 1 EXTENSION
The biggest and the most complicated one to date, it has been subjected to repeated feasibility studies. The first bidding in August 2013 failed due to misallocation of risk (shifting to the private sector the uncertainty of real property taxes) and the insufficiency of allowed subsidy. It was rebid in May this year with the lone bidder (out of seven prequalified) winning. The award was delayed to September by a still ongoing legal tussle involving the location of a “common station” shared with another rail line.
MACTAN-CEBU AIRPORT TERMINAL
Seven bidders showed up in November 2013, with the consortium of Megawide Construction Group, which partnered with India’s GMR Infrastructure, winning the bid. Citing conflict of interest, the losing bidder challenged the qualifications of the winning group, which was then subjected to a Senate inquiry. Even with a legal challenge filed before the Supreme Court, the project was awarded in April, delayed by a few months.
CAVITE-LAGUNA EXPRESSWAY
Four groups vied in the June bidding, with the SMC consortium disqualified based on a noncompliant bid bond. Of the three remaining, the Ayala-Aboitiz consortium offered the highest premium, amounting to P11.66 billion. The SMC group claimed that it would have won with a P20 billion had it not been disqualified on a “technicality.” It appealed to the President to overturn its disqualification and the Palace issued an order in late June suspending the awarding of the project. The issue has yet to be resolved.
(Next week: Moving forward)
This piece is based on a GlobalSource report by Christine Tang and Romeo Bernardo
Romeo Bernardo was finance undersecretary during the Cory Aquino and Ramos administrations, and board director of Institute of Development and Econometric Analysis Inc.
========================================================================
(to be published Nov 10)
Moving forward
From where it started in 2010, government has made significant strides in terms of project awards and in building a pipeline of PPP projects using the donor-supported Project Development and Monitoring Fund (PDMF). The PDMF framework has led to a coherent, solicited and transparent government-led PPP program, a departure from the past where projects originated via the private sector-driven, unsolicited route. Donor assistance has also gone into strengthening technical capacity in government agencies for identifying and implementing projects suited for PPP and to a more limited extent, drawing up sectoral master plans that map out project requirements.
Notwithstanding the above, the PPP program is still a work in progress (with proposed changes to the legal framework pending in Congress) and continues to be at risk of sliding to stall speed.
For starters, success to date has been based on selecting projects that were either relatively simple to do or had ready feasibility studies sourced either from past technical assistance or unsolicited proposals. The risk now is of exhaustion of feasibility studies for projects that may be undertaken as PPP. While the PDMF is envisioned to be self-sustaining, seed funds provided by donors are at risk of becoming depleted as there is a gap/ time lag in its replenishment via reimbursement from awarded projects. Also, while it would be fair to assume that the contract models now in place for each of the sectors awarded would make it easier to do succeeding ones, we think that the challenge of bringing seemingly similar projects to market will remain a slow process due to the many idiosyncratic factors, including political ones and even at the local government levels, that affect different projects’ risk profiles differently.
Moreover, as the program moves away from brownfield projects, where there are existing and predictable revenues streams, to riskier greenfield projects with uncertain demand, the as yet unknown unknowns can be expected to contribute to longer project cycles. One example is the newly rolled out P123-billion expressway dike project, the biggest one by far, which we understand will have to hurdle challenges from competing tollroad concessions that may see their traffic volume diverted to the new road as well as a skewed cashflow profile with the huge upfront cost to be recovered from revenues too far into the future.
The policy environment
As PPP projects become bigger, riskier and more complex, government will also need to assess its own appetite for taking bolder measures to de-risk projects and provide stronger assurances to investors that it will be able to fulfill contract promises. So far, the general impression is that due to its unpleasant experience with realized contingent liabilities in the past, government has been overly cautious in assuming risks in PPPs. Even if government were prepared to assume more risks, its ability to do so in the short-term would be constrained by the lack of a medium-term expenditure framework that would enable it to commit resources to long-gestating PPP projects over successive administrations and protect projects from politicization. For instance, we expect that two long-term public financial support mechanisms will become more important over time, but both will probably need legislation.
One is an automatic payment mechanism where annual appropriations will be allowed to accumulate and used automatically for payouts in case of government contract breach, similar to the treatment of debt repayments. This would be a more permanent structure compared with the current setup where a “Contingent Liability Fund“ item is lodged under “unprogrammed funds” in the budget and expires every year and would have to be appropriated anew every year. Similarly, a separate long-term fund is needed to meet so-called “availability payments” for projects that rely partly or wholly on government payments for financial viability (Examples include the classrooms and hospital projects as well as PPP structures similar to the take-or-pay power contracts in the 1990s). At present, government is relying on an instrument called multi-year obligation authority (MYOA) that commits the executive to include the required payments in the annual budget over the project period; but it is non-binding on the legislature which approves the budget, thus exposing investors to risk of non-appropriation by congress every year.
There is additionally the challenge of sustaining competitive pressures by expanding the pool of potential bidders beyond the current list of mostly large local conglomerates, which will be crucial to safeguarding the bidding process and ensuring that government receives the best price. So far, the seemingly high concession payments on awarded projects suggest adequate competition but which we think may be more properly traced to extraneous factors – current low interest rate environment and upsides from real estate development that have enhanced forecast revenues beyond a “project only” analysis – that may not be relevant in future projects. In the event, Constitutional restrictions particularly on public utilities may become binding constraints to ramping up PPP deals.
Postscript
The challenges notwithstanding, we think that the PPP program will continue to be a necessary feature of the country’s infrastructure program not only because of constrained public resources but more importantly because it enables government to tap into private sector technical, financial and managerial expertise. But even as government is devoting a lot of resources on developing and marketing new deals, it should probably also pay mind to how it treats its private partners in ongoing PPP projects. Recent reports of backtracking from market-based electricity rate setting, reinterpretation of the concession agreement with water concessionaires on the recoverability of corporate income taxes, and the delays in rate adjustments in mass transport and toll roads put the stability of the country's regulatory environment in a bad light.
At the end of the day, it is the assurance of a predictable legal and regulatory environment during the bidding and award stage and over project life that will kindle private sector interest and achieve value for money for the public sector.
Introspective
After a false start and a few years limping along, the Aquino government’s flagship PPP program finally roared to life. In relatively quick succession, the government bid out or awarded four projects worth P125 billion and rolled out six more costing about P170 billion. What was particularly surprising was that the auctions yielded substantial concession fee payments to the government, as against pre-bid financial model results showing that the government would have to provide subsidies to enhance project cash flows.
Encouraged by the successes, the government through the PPP Center has lined up another seven projects worth about P180 billion for approval by the National Economic and Development Authority (NEDA) board, and is preparing feasibility studies for 10 other projects. In all, there are about 50 projects in the PPP Center’s pipeline which the government is also actively marketing to foreign investors through a series of international road shows.
The mood has not always been this upbeat due largely to unmet expectations following the government’s high publicity launch of the program back in 2010. Then, the much-hyped “PPP is the solution to the infrastructure shortage in the country” failed to consider that in the wake of controversies surrounding failed PPPs in the past, both sides of the partnerships had their guard up and were distrustful of each other. In particular in the aftermath of the Asian crisis, the public sector had to grapple with and absorb some of the liabilities in PPP contracts, and for years leading up to 2010 preferred to manage the risks from contingent liabilities by avoiding them altogether. In turn, the private sector was particularly leery of government contract promises that the latter had time and again failed to keep, notably delays in tariff adjustments in most sectors -- power, water, rail, toll roads -- particularly during politically sensitive periods.
Moreover, there were very few market-ready projects in the pipeline at the time and fast-tracking last-mile adjustments to ready projects was constrained by technical limitations in implementing agencies. It was thus a slow process of learning by doing on a per-project basis, tentatively delineating risks among the parties involved, with the government deftly testing what risks the market could bear through actual biddings of smaller projects.
These included (a) a small 4-kilometer (km) toll road in December 2011 that very soon became stuck in right-of-way (ROW) disputes, and (b) a project to build classrooms, awarded in September 2012, that was the first of its kind in that it relied solely on government payments for its cash flows and thus was not able to attract more bidders willing to assume congressional appropriations risk. Critics also pointed out that this project and its second phase the following year lacked features of true PPPs in that the private sector merely handled construction of the schools and were not exposed to market and operating risks.
The first major win for the Aquino government was the P15.5-billion, 7.75-km, four-lane elevated NAIA Expressway project that had been in the drawing board for decades and was finally brought to market with donor technical assistance. Albeit it attracted only two bidders, the auction, won by a consortium led by one of the large domestic conglomerates (SMC) in May 2013, yielded P11 billion in concession fees to the government and by early 2014 had already broken ground. Another win six months later was a five-way bid in November to install a P1.7-billion single-ticketing system for Metro Manila’s rail system, where the winning bid was a P1.1-billion payment to the government.
But it has not become easier. The latest auctions, involving three multibillion-peso transport projects, have been uphill struggles for both the government and the private sector. The challenges that have emerged during the bid stage are reminders of the inherent difficulty and associated time lag of doing PPPs, especially in a developing country like the Philippines where institutions remain weak and bidders take for granted that calling on the courts, Congress or the President to intervene on their behalf is part of the rules of the game. Such politicization of the formal PPP processes tarnishes the program’s image and dulls investors’ appetites. Here are a few of the project holdups:
LRT LINE 1 EXTENSION
The biggest and the most complicated one to date, it has been subjected to repeated feasibility studies. The first bidding in August 2013 failed due to misallocation of risk (shifting to the private sector the uncertainty of real property taxes) and the insufficiency of allowed subsidy. It was rebid in May this year with the lone bidder (out of seven prequalified) winning. The award was delayed to September by a still ongoing legal tussle involving the location of a “common station” shared with another rail line.
MACTAN-CEBU AIRPORT TERMINAL
Seven bidders showed up in November 2013, with the consortium of Megawide Construction Group, which partnered with India’s GMR Infrastructure, winning the bid. Citing conflict of interest, the losing bidder challenged the qualifications of the winning group, which was then subjected to a Senate inquiry. Even with a legal challenge filed before the Supreme Court, the project was awarded in April, delayed by a few months.
CAVITE-LAGUNA EXPRESSWAY
Four groups vied in the June bidding, with the SMC consortium disqualified based on a noncompliant bid bond. Of the three remaining, the Ayala-Aboitiz consortium offered the highest premium, amounting to P11.66 billion. The SMC group claimed that it would have won with a P20 billion had it not been disqualified on a “technicality.” It appealed to the President to overturn its disqualification and the Palace issued an order in late June suspending the awarding of the project. The issue has yet to be resolved.
(Next week: Moving forward)
This piece is based on a GlobalSource report by Christine Tang and Romeo Bernardo
Romeo Bernardo was finance undersecretary during the Cory Aquino and Ramos administrations, and board director of Institute of Development and Econometric Analysis Inc.
========================================================================
(to be published Nov 10)
Moving forward
From where it started in 2010, government has made significant strides in terms of project awards and in building a pipeline of PPP projects using the donor-supported Project Development and Monitoring Fund (PDMF). The PDMF framework has led to a coherent, solicited and transparent government-led PPP program, a departure from the past where projects originated via the private sector-driven, unsolicited route. Donor assistance has also gone into strengthening technical capacity in government agencies for identifying and implementing projects suited for PPP and to a more limited extent, drawing up sectoral master plans that map out project requirements.
Notwithstanding the above, the PPP program is still a work in progress (with proposed changes to the legal framework pending in Congress) and continues to be at risk of sliding to stall speed.
For starters, success to date has been based on selecting projects that were either relatively simple to do or had ready feasibility studies sourced either from past technical assistance or unsolicited proposals. The risk now is of exhaustion of feasibility studies for projects that may be undertaken as PPP. While the PDMF is envisioned to be self-sustaining, seed funds provided by donors are at risk of becoming depleted as there is a gap/ time lag in its replenishment via reimbursement from awarded projects. Also, while it would be fair to assume that the contract models now in place for each of the sectors awarded would make it easier to do succeeding ones, we think that the challenge of bringing seemingly similar projects to market will remain a slow process due to the many idiosyncratic factors, including political ones and even at the local government levels, that affect different projects’ risk profiles differently.
Moreover, as the program moves away from brownfield projects, where there are existing and predictable revenues streams, to riskier greenfield projects with uncertain demand, the as yet unknown unknowns can be expected to contribute to longer project cycles. One example is the newly rolled out P123-billion expressway dike project, the biggest one by far, which we understand will have to hurdle challenges from competing tollroad concessions that may see their traffic volume diverted to the new road as well as a skewed cashflow profile with the huge upfront cost to be recovered from revenues too far into the future.
The policy environment
As PPP projects become bigger, riskier and more complex, government will also need to assess its own appetite for taking bolder measures to de-risk projects and provide stronger assurances to investors that it will be able to fulfill contract promises. So far, the general impression is that due to its unpleasant experience with realized contingent liabilities in the past, government has been overly cautious in assuming risks in PPPs. Even if government were prepared to assume more risks, its ability to do so in the short-term would be constrained by the lack of a medium-term expenditure framework that would enable it to commit resources to long-gestating PPP projects over successive administrations and protect projects from politicization. For instance, we expect that two long-term public financial support mechanisms will become more important over time, but both will probably need legislation.
One is an automatic payment mechanism where annual appropriations will be allowed to accumulate and used automatically for payouts in case of government contract breach, similar to the treatment of debt repayments. This would be a more permanent structure compared with the current setup where a “Contingent Liability Fund“ item is lodged under “unprogrammed funds” in the budget and expires every year and would have to be appropriated anew every year. Similarly, a separate long-term fund is needed to meet so-called “availability payments” for projects that rely partly or wholly on government payments for financial viability (Examples include the classrooms and hospital projects as well as PPP structures similar to the take-or-pay power contracts in the 1990s). At present, government is relying on an instrument called multi-year obligation authority (MYOA) that commits the executive to include the required payments in the annual budget over the project period; but it is non-binding on the legislature which approves the budget, thus exposing investors to risk of non-appropriation by congress every year.
There is additionally the challenge of sustaining competitive pressures by expanding the pool of potential bidders beyond the current list of mostly large local conglomerates, which will be crucial to safeguarding the bidding process and ensuring that government receives the best price. So far, the seemingly high concession payments on awarded projects suggest adequate competition but which we think may be more properly traced to extraneous factors – current low interest rate environment and upsides from real estate development that have enhanced forecast revenues beyond a “project only” analysis – that may not be relevant in future projects. In the event, Constitutional restrictions particularly on public utilities may become binding constraints to ramping up PPP deals.
Postscript
The challenges notwithstanding, we think that the PPP program will continue to be a necessary feature of the country’s infrastructure program not only because of constrained public resources but more importantly because it enables government to tap into private sector technical, financial and managerial expertise. But even as government is devoting a lot of resources on developing and marketing new deals, it should probably also pay mind to how it treats its private partners in ongoing PPP projects. Recent reports of backtracking from market-based electricity rate setting, reinterpretation of the concession agreement with water concessionaires on the recoverability of corporate income taxes, and the delays in rate adjustments in mass transport and toll roads put the stability of the country's regulatory environment in a bad light.
At the end of the day, it is the assurance of a predictable legal and regulatory environment during the bidding and award stage and over project life that will kindle private sector interest and achieve value for money for the public sector.
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