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China must put the 'private' into PPP

Beijing can use borrowing crackdown to overhaul key infrastructure financing tool

| China
Beijing should establish clear standards for evaluating public-private partnership projects and make them genuinely open to private companies.

Public-private partnerships are not trendy in China anymore.

The authorities in recent months have canceled about 2,500 PPPs, worth around 2.39 trillion yuan ($376 billion) in aggregate, after Beijing concluded that local governments were abusing the infrastructure financing arrangement to circumvent controls on their borrowing, adding to a worrisome growth in public debt. The halted projects represent about 18% of those in the official pipeline.

It is critical however that China not give up on PPPs simply because of the misbehavior of some local governments. Beijing should instead use the current cleanup to establish clear standards for evaluating PPP bids and bidders while improving its own capabilities to conduct such analysis. The authorities should make clear that the "private" side of PPP will be genuinely open to private companies, including foreign ones, rather than allow PPPs to be limited to a closed club of government-owned entities.

Even with the many highways, airports and bridges that have been built in China in recent years, there remains much to be done. The Asian Development Bank last year estimated China's annual infrastructure investment need through 2020 at $753 billion while projecting an expected average shortfall of $68 billion a year. If properly administered, PPPs can be a critical tool for bringing in private-sector skills and financing to fill this gap.

Chinese officials began to adopt the PPP model only in 2014. In under four years, about 14,000 projects, valued at over 20 trillion yuan, had been initiated, a staggering amount even by Chinese standards.

More than 60% of the companies involved are state-owned entities, according to analysis of a sample of 572 projects by the Ministry of Finance's China Public Private Partnerships Center. The center found that just 4% of PPP participating companies came from Hong Kong, Macau or Taiwan, with another 2% coming from other countries. The balance of participants were Chinese private companies.

The issue for Beijing however was that some local governments structured their PPPs as a de facto borrowing arrangement. In these cases, the PPP partner was promised a fixed return at regular intervals from land sale revenues -- comparable to loan interest -- and a guarantee that the local authority would buy out the partner's equity stake in the project at a set time, effectively repaying the loan principal. This quasi-borrowing, again often involving state-owned companies, was not recorded as debt on the local authorities' books.

As the Chinese Ministry of Finance grew concerned with the ramifications of runaway PPPs late last year, provincial finance bureaus were tasked with canceling improper projects by March 31. They were told to look out for PPPs where officials had failed to evaluate potential investment returns or conduct fiscal stress tests; where progress had been poor or information transparency lacking; where spending had gone over budget; or where company debts had been illegally guaranteed.

The PPP purge, which is likely to continue, may actually not be a bad thing for China Inc. A significant number of enthusiastic Chinese players moved into PPPs without any clear understanding of the potential risks and limited relevant operational experience.

Consider some of the Chinese companies making their debut in infrastructure with PPPs. Conglomerate Fosun International, known for its operations in insurance, resorts and pharmaceuticals, became the first private company to invest in a Chinese high-speed rail project, the $6.9 billion Hangzhou-Taizhou line. Sichuan Yibin Yili Group, a munitions manufacturer and distributor, was awarded a PPP contract to build and operate a 130km expressway in Sichuan Province.

Do these companies really know what they are getting themselves into? Their expertise in insurance and explosives does not necessarily translate into designing, constructing, financing and operating a train line or highway.

To help create a credible PPP sector, Beijing must become stricter in evaluating bids and bidders. This will require the government to upgrade its screening capabilities to help weed out sweetheart favors. PPP projects should be evaluated on the soundness of the business case and executed by a consortium of companies which have the right experience and knowhow across all relevant technical, financial and operational dimensions of the project.

All the risks need to be understood upfront and priced in accordingly. There needs to be a realistic financial forecast including volume projections and future maintenance and capital expenditure requirements. Tools and frameworks need to be adopted that allow for transparent evaluation and decision-making. This expertise needs to reside both with the bidders and the respective government agencies tasked with evaluating and awarding projects.

If bidders are overly aggressive, they will not be able to generate the revenues they expect and service their debts. The government may then have to step in to salvage their projects, so it is in the authorities' interests to ensure that forecasting is credibly done.

If the authorities lack the capability to properly evaluate bids or run a true competitive bidding process then they may leave too much money on the table. This would be a bad deal for taxpayers and run counter to what the government should be aiming for with PPPs, namely getting better value from its infrastructure projects.

PPPs can offer China better value and an alternate source of funding and innovation. However, it is critical that projects be awarded based on sound business cases to parties with the right knowhow and experience to ensure success.

This will require a dramatic upgrade in the capabilities of both bidders and government officials tasked with awarding and evaluating bids. A balanced, multidisciplinary approach is essential for PPPs to be of long-term value to China's infrastructure buildout.

Michel Brekelmans is managing director at SCP/Asia, a Singapore-based consulting firm that supports companies in business strategy development, organizational improvement and M&A services. He previously worked with a Chinese engineering design company on its PPP strategy.

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