The Challenges of Public-Private Partnerships in Agriculture and the Rural Sector
by ARSENIO M. BALISACAN
Secretary of Socioeconomic Planning
2013 Asia Pacific Agriculture Policy (APAP) Roundtable
1-2 April 2013
It is quite timely that I stand here before you today to give the keynote speech on the challenges of public-private partnership (PPP) in agriculture and the rural sector in developing countries. I say it is “timely” because at this point, the Philippines, a developing country, has had adequate experience in PPP, starting from the enactment of our “Build-Operate-Transfer (BOT) Law” in 1990, which enables me to speak significantly about the issues and challenges that need to be addressed to ensure the success of a PPP program, especially in agriculture.
It is also “timely” because developing countries of diverse institutional and technological capabilities have been moving toward deeper economic integration despite the long stalemate in the multilateral trade negotiations under the auspices of the World Trade Organization (WTO). Indeed bilateral and mini-lateral free trade agreements (FTAs), such as the ASEAN-led Regional Comprehensive Economic Partnership (RCEP) and the US-led Trans-Pacific Partnership (TPP), have been increasingly becoming ubiquitous. In Southeast Asia, the ASEAN-member countries are in various stages of preparation for the dawn of the ASEAN Economic Community in 2015. The question to ask is, what strategies should developing countries in the region, such as the Philippines, Myanmar, and Indonesia, pursue to realize the full benefits from regional integration? At present, despite recent advances in the agriculture sector, productivity and competitiveness remain a major challenge in each of these countries.
Perhaps the most binding constraint to productivity growth of agriculture in the developing world is the absence or inadequacy of efficient infrastructure system, particularly transport, power supply, and communication infrastructure. The immediate consequence is the high transaction costs of doing business in rural areas, effectively inhibiting farmers from taking advantage of opportunities in rapidly growing areas and urbanizing centers, including foreign markets for exports. In addition, with the more prevalent changes in average weather conditions nowadays, and given the sector’s vulnerability to climate-related risks, the need for infrastructure that would help farmers cope with the effects of climate change is more urgent now than ever before.
The second set of binding constraints relates to the regulatory and policy regime for agriculture. High tariffs and quantitative restrictions set up to achieve, say, food self-sufficiency goals induce inefficiency in production and consumption choices, dampen competitiveness and productivity, encourage rent-seeking behavior, and ultimately hurt the poor who are usually net buyers of food.
Partly because of high transaction costs and the high co-variance of production risks in agriculture, access to finance is far more limited for small and medium farmers, especially in developing countries, compared to their counterparts in manufacturing sector or urban areas. The inadequacy of working capital holds back the adoption of modern technologies embodied in new plant varieties, farm equipment, post-harvest facilities, etc. Even in cases where productivity-enhancing technologies are available, farmers too remote and too poor to purchase the inputs to use the technologies do not benefit from these innovations.
Considering the numerous development priorities and programs that governments of developing countries attend to in order to address the binding constraints to economic growth and poverty reduction, including those for agriculture, investment partnership with stakeholders, particularly the private sector, is deemed crucial. It is in this context that PPP schemes are increasingly being utilized to implement certain public sector programs and projects. In a PPP arrangement, it is recognized that the public sector and the private sector have strengths and advantages that they could bring together to deliver a project and/or service of mutual interest, through the sharing of funds, technologies, skills, and other assets.
Often, the chief rationale for entering into PPPs is the need for the public sector to augment its resources. By getting the private sector to invest in facilities (including the provision of associated services), which are traditionally provided by the government, a significant amount of public resources can be freed up for the provision of other needs and social protection, which are not financially feasible nor bankable to enable private sector participation. Other important considerations of the government in partnering with the private sector are the need to tap new technology and innovation and to harness the private sector’s operational efficiency under contractually-set performance standards and its drive to maximize return on total invested capital and equity. This operational efficiency can drive down the life-cycle or whole-of-life costs of a project, enhancing its value-for-money and net economic benefits.
In general, PPPs are undertaken within the context of broad reform objectives as it reallocates roles in service delivery, capital mobilization, and in attaining operational efficiency, among others. In embarking on a PPP program, it is important to realize at the outset that a PPP arrangement is a procurement option that involves a long-term commitment, often defined by the life of a project, between the government and the private partner. It is important to realize, as well, that while the private sector may finance, construct, operate and maintain, or manage the PPP project, the government retains the ultimate responsibility and accountability to society for achieving developmental outcomes, such as meeting basic needs, at the very least. The private sector’s responsibility is limited to its obligations under the PPP contract.
In undertaking a PPP program, the public sector needs to establish the policy, legal, regulatory and institutional frameworks to start with. The policy framework would provide the rationale for entering into PPPs, including the process for entering into such arrangements. It should be noted that the private sector goes only where commercial incentives abound to generate returns to their efforts on product development and deployment. Then, the government needs to establish at the outset the viability of a project and its attendant risks, in order to guide its implementation structure. This will be whether as a PPP project or otherwise, including the proportion of ownership that the public sector would assume, as it would have implications on the role of the government vis-à-vis that of the private partner. For example, if the government chooses to fully privatize a specific asset and related services, its participation would be limited to regulation and establishment of an enabling environment. On the other hand, if it chooses to retain 100 percent ownership, it would assume the role of provider and would bear all risks attendant to the project.
Aside from the policy framework, a legal framework is also needed to ensure that long-term PPP contracts are effective and enforceable. Moreover, a regulatory framework needs to be put in place to provide the necessary technical, safety, and economic safeguards in the enforcement of a PPP contract. However, the public sector can choose to undertake regulation through the PPP contract itself or through an independent regulator for a given sector.
In a PPP arrangement, the government can transfer some of the risks of a project to the private partner. The risk allocation is based on the principle that the party taking on the risk is the one that is best able to manage the risk to ensure the success of the project, particularly the value-for-money aspect. As compensation for its investment and for taking on some of the risks, an appropriate return is given to the private partner, which is recovered through third party/users in the form of user charges, fares, etc.
Broadly, PPPs can be categorized into two types: (1) those which have a high potential of being both economically and financially viable such as toll roads; and (2) those that are economically viable but are inherently not financially viable such as hospitals, correctional facilities, and agriculture-related projects (e.g., irrigation). In these two broad categories of PPPs, the risk profiles and allocation are different. In the first type where demand is potentially robust, notwithstanding optimism bias that is usually present in forecasting, the market or demand risk is borne by the private partner. In the second category of PPPs, which are considered ‘social’ in nature, the government usually bears the demand risk. The transaction is often through an availability-based payment mechanism where the government’s payment to the private partner is based upon the availability of the facility.
In the agriculture sector, programs and projects have a risk profile that is dominated by seasonality issues and force majeure risks in the form of natural disasters (e.g., typhoons and droughts) and climate change-related effects, among others. Also, poor connectivity often aggravates the situation. Accordingly, potential PPP projects in the agriculture sector lean towards the second PPP category, where the government may have to provide subsidies, incentives, or availability payments to attract private sector participation. Given the nature of agriculture projects and the inherent risks in the sector, the government needs to find ways to make agriculture projects commercially viable. This is either through an optimal sharing of risks or through a transaction structure that would strike a balance between safeguarding public interest by ensuring that a project has a net economic benefit and making the project attractive to the private sector. The government and the private partner could also explore other factors that would achieve such balance through new technologies and innovations that would drive down whole-of-life costs, thus making a program or project economically and financial viable.
Despite the progress made so far with PPP implementation by a number of countries worldwide, it is recognized that a number of challenges still need to be addressed. First is the need to capacitate implementing agencies or entities in packaging PPP projects, particularly agriculture projects, to ensure that they are bankable and attractive for private investment, while ensuring that they provide net economic returns. As mentioned earlier, while so many projects are viable economically, a number of them are not financially feasible, thus necessitating incentives such as subsidies, in the form of viability gap funding (VGF), from the public sector. Also, where there is uncertainty in the market demand, the private sector sometimes asks for guarantees to enable them to realize their expected return, such as ‘take-or-pay’ provisions. In all cases, the government needs to strengthen its capacity for risk management so as not to expose the public sector to significant fiscal risks and contingent liabilities under the PPP contracts. This avoids projects becoming economically unviable in the long run should such fiscal risks become real liabilities.
While PPPs are good vehicles for mobilizing capital and tapping private sector efficiency, they are also very complex arrangements that necessitate capacity development of the public sector in the areas of finance (investment, valuation, etc.), risk management (including management of contingent liabilities), and contract management, among others. It is important to realize that capacity development need be institutionalized given that PPP contracts are long-term in nature. Moreover, in view of the fiscal implications (e.g., VGF, guarantee arrangements, etc.) of some PPP projects, setting the policy framework, along with the legal and regulatory frameworks, needs to be established at the outset, with due consideration to attaining the best value-for-money.
In closing, let me reiterate that PPPs have the potential of augmenting the public sector’s fiscal resources and for efficiently managing facilities. However, if structured poorly, PPPs can also lead to significant fiscal liabilities. Therefore, there is a need to establish the guiding frameworks at the outset and ensure that concerned agencies and agents of government that would be involved in PPPs are capacitated in the areas I have previously mentioned. In the agriculture sector, private sector partnership has the potential of expanding the provision of needed facilities and services in the sector. However, sustainable PPP transaction structures or models need to be established first to take into consideration the distinct characteristics of the sector, particularly the attendant risks. It is seen that new innovations and technology, as well as adaptive measures, will play an important role in mitigating the inherent risks in the sector to make agriculture projects more attractive for private sector participation.
Lastly, let me remind everyone that PPP is not automatically the right scheme or the default procurement mode to venture into. However, as Marco Ferroni and Paul Castle (2011) noted, when “the right partners come together in the right way, the synergies they achieve can lead to results well beyond the reach of any one organization or institution alone.” PPPs have considerable scope for expansion, especially in the agriculture sector.
Best wishes to your own PPP endeavors. Thank you all.
NEDA Press Release, 02 April 2013