David Duarte Arancibia Budget Office Ministry of the Treasury April, Concessions, their fiscal impact

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1 Concessions, their fiscal impact David Duarte Arancibia Budget Office Ministry of the Treasury April, 2009 Concessions, their fiscal impact 1

2 Outline Concession system The system s financial guarantees The system s fixed commitments Fiscal planning Financial management of the system Recommendations Concessions, their fiscal impact 2

3 Concession system Objectives Reduce the infrastructure deficit Eliminate bottlenecks for economic growth Maintain discipline in fiscal expenditure Avoid increasing the public debt Improve efficiency: investment/maintenance trend Financing of users Concessions, their fiscal impact 3

4 Concession system Origin Solution Encourage private participation in provision of infrastructure, Public-Private Partnership (PPP or concessions) Concession: Private firm (Designs), Finances, Constructs, Operates, Exploits for a given number of years and delivers an infrastructure work to the government Concessions, their fiscal impact 4

5 Concession system Actors involved Budget Office, Ministry of the Treasury Fiscal impacts Social evaluation Planning Ministry Concession Coordination Office Ministry of Public Works Legal review Comptroller s Office Concessions, their fiscal impact 5

6 Concession system Keys Flexible legal framework Open to competition Private initiatives Possibility to terminate the concession Dispute resolution system Financial guarantees Compatible financial legislation Concessions, their fiscal impact 6

7 Outline Concession system The system s financial guarantees The system s fixed commitments Fiscal planning Financial management of the system Recommendations Concessions, their fiscal impact 7

8 Financial guarantees granted by the State Guaranteed minimum income (revenue sharing) Exchange coverage mechanism Variable term mechanisms Other specific guarantees in some contracts (El Melón tunnel, Chiloé bridge) Concessions, their fiscal impact 8

9 Financial guarantees Guaranteed minimum income Income [UF] Ceiling on income Expected income Guaranteed minimum income Concessions, their fiscal impact Time 9

10 Financial guarantees Guaranteed minimum income Income [UF] The concessionaire must share income with the government Actual performance of income The government pays the concessionaire the difference between actual income and the GMI Concessions, their fiscal impact Time 10

11 Financial guarantees Guaranteed minimum income If activated, the concessionaire can pay the financing (objective function in the plan) If activated, the project is unprofitable as a private venture A premium is charged for access to the mechanism Market test of project feasibility Lower financing costs Disincentive for government to build substitutes Concessions, their fiscal impact 11

12 Financial guarantees Exchange coverage mechanism Chile s financial market was leaner in the 1990s Less knowledge about the concessions industry Less knowledge about how the industry s financial rules work Some concessionaires could get better financing terms abroad Concessions, their fiscal impact 12

13 Financial guarantees Exchange coverage mechanism TC=Exchange rate US$/UF TC 1,1*TC 0 TC 0 0,9*TC 0 Financing (short term) Refinancing (long term) Time Disbursements Debt service Concessions, their fiscal impact 13

14 Financial guarantees Exchange coverage mechanism TC=Exchange rate US$/UF 1,1*TC 0 The concessionaire pays the government when the currency appreciates more than 10% The concessionaire may abandon the mechanism if it thinks the appreciation is permanent TC TC 0 0,9*TC 0 Time The government pays the concessionaire when the currency depreciates more than 10% Debt service Concessions, their fiscal impact 14

15 Financial guarantees Exchange coverage mechanism US$/UF Evolution of exchange rate Signing of mechanism Beneficial for concessionaires Currency appreciates strongly with permanent expectations, Mechanism abandoned 0 Jan/99 May/99 Sep/99 Jan/00 May/00 Sep/00 Jan/01 May/01 Sep/01 Jan/02 May/02 Sep/02 Jan/03 May/03 Sep/03 Jan/04 May/04 Sep/04 Jan/05 May/05 Sep/05 Jan/06 May/06 Sep/06 Jan/07 May/07 Sep/07 Jan/08 May/08 Sep/08 Jan/09 Concessions, their fiscal impact 15

16 Financial guarantees Exchange control mechanism At present all concessionaries have abandoned the mechanism The domestic financial market, eager for long-term UF bonds, and government financial guarantees, have enabled them to get excellent placement rates Currently can generate private coverage Concessions, their fiscal impact 16

17 Financial guarantees Variable term mechanisms Income [UF] Estimated concession duration Income expected from concession Income expected from concession Time Concessions, their fiscal impact 17

18 Financial guarantees Variable term mechanisms Income [UF] Estimated concession duration Income expected from concession Income expected from concession Actual duration of concession Time Concessions, their fiscal impact 18

19 Financial guarantees Variable term mechanisms Income [UF] Estimated concession duration Income expected from concession Actual duration of concession Time Concessions, their fiscal impact 19

20 Financial guarantees Lower Present Value of Income (LPVI) Sets total income of concession in tender process Mitigates demand risk Reduced likelihood of bankruptcy Better quality offerings Encourages fairer negotiations Does not guarantee profitability Concessions, their fiscal impact 20

21 Financial guarantees Income Distribution Mechanism (IDM) Mechanism offered to concessionaires in operation in 2001 Some concessions needed additional works Income had been less than expected Concessionaires had negative expectations The government thought flows would increase regardless of the macroeconomic cycles Concessions, their fiscal impact 21

22 Financial guarantees Income Distribution Mechanism (IDM) Changing expectations opens room for negotiation Concessionaires chose the income growth rate In return they had to pay the government a percentage of the current value of the income The contract was changed from fixed-term to variable The concessionaires cannot get out of the IDM Concessions, their fiscal impact 22

23 Financial Guarantees During planning Each guarantee is for a specific purpose and cannot be used to artificially increase a project s profitability During the bidding there is pressure for increasing the values (all interested parties in bidding for the project) There is assymetry of information, because the plan is made presupposing a financial structure known only to the concessionaire Concessions, their fiscal impact 23

24 Financial Guarantees From the fiscal viewpoint The guarantees affect the economic cycle (pro-cyclical) so must be controlled Impact on country risk Hard to estimate because of their contingent nature Not reflected in fiscal budget Concessions, their fiscal impact 24

25 Financial Guarantees As regards control: Models developed with World Bank permit estimation of probability of payment Permits estimation of current value and reporting it in the Contingent Liabilities Report of the Budget Office Also permits calculating and charging that amount for access to them so private parties assess the real need Concessions, their fiscal impact 25

26 Outline Concession system The system s financial guarantees The system s fixed commitments Fiscal planning Financial management of the system Recommendations Concessions, their fiscal impact 26

27 The system s fixed commitments Sources Subsidies Payments for assets and rights Supplementary agreements Other payments (control, management, studies, etc.) Government-concessionaire disputes Concessions, their fiscal impact 27

28 The system s fixed commitments Subsidies Government payments to concessionaire in addition to tariff income Occur when tariff income is insufficient to make private investment profitable and attractive (there is a tariff cap) Projects with no income: jails Concessions, their fiscal impact 28

29 The system s fixed commitments Payments for assets and rights In some cases, income from tariff makes private investment very profitable There is a reasonable minimum tariff That tariff allows the concessionaire to make payments to the government During bidding, the excess-profitability diminishes with higher payments to the government Concessions, their fiscal impact 29

30 The system s fixed commitments The Route 5 case 1520 Km, Concessions granted for 8 sections Trunk route that connects the country Decision: Fixed tariff In some sections it was necessary to have subsidies and in others, payments to the government Plan for crossed subsidies Concessions, their fiscal impact 30

31 The system s fixed commitments Supplementary agreements The contracts do NOT cover all possible future situations of the type Long-term contracts Uncertain variables: (Flows, demography, economic growth, macroeconomic variables, policies) Concessions, their fiscal impact 31

32 The system s fixed commitments Supplementary agreements Grounds for changes: Expansion needs Aspects not covered by the contract Incomplete studies Solution of government-concessionare disputes Regulatory changes Increased standards Social needs Political decisions Lack of moderation, haste to grant concession Opportunities Concessions, their fiscal impact 32

33 The system s fixed commitments Supplementary agreements Logic of the Negotiation: Reestablish the financial balance of the contract This can be accomplished by providing for: Payments to the government (1 or more) Raising the tariff Extending the duration Concessions, their fiscal impact 33

34 The system s fixed commitments Supplementary agreements Payments to the government Requires availability of resources Payment in more than a single installment entails additional financial cost It is possible to take advantage of favorable financial conditions to use it Reduces the opportunity for new projects or investments Concessions, their fiscal impact 34

35 The system s fixed commitments Supplementary agreements Raising the tariffs No government resources required High political cost Complex negotiation of elasticity In some cases agreements for investments must be made with concessionaires unwilling to carry them out if compensated by this means Concessions, their fiscal impact 35

36 The system s fixed commitments Supplementary agreements Extending duration No government resources needed Postpones a current problem Usually has a high financial cost (more distant flows over time are more uncertain) Postpones the rebidding or expansion of the work Concessions, their fiscal impact 36

37 The system s fixed commitments Supplementary agreements Characteristics Any alteration may have a financial impact on the contract They must be authorized by the Ministry of the Treasury Lengthy negotiations, so there must be a rapid-reaction mechanism Concessions, their fiscal impact 37

38 The system s fixed commitments Supplementary agreements Problems The concessionaires capture the government (urgent projects, projects already begun, etc.) At times the contract is modified to solve a problem that is a government responsibility, so negotiations are hasty and the results are less than desirable Assymetry of information on real costs (works and financing) Concessions, their fiscal impact 38

39 The system s fixed commitments Supplementary agreements Problems The amount of compensation is the product of bilateral negotiations (no competition) Hard to predict Fiscal surprises Cost overruns average 30% In some cases they are as high as 100% Concessions, their fiscal impact 39

40 The system s fixed commitments Supplementary agreements Fiscal flows in stylized profiletypes Caso Rentable Esperado Caso Rentable Real Caso No Rentable Real Concessions, their fiscal impact 40

41 The system s fixed commitments Supplementary agreements Measures High quality of engineering - studies Proper specification of contracts Efficient risk allocation Proper system selection (BOT, DBOT, Service Level) Feedback Budgetary provisions Concessions, their fiscal impact 41

42 Outline Concession system The system s financial guarantees The system s fixed commitments Fiscal planning Financial management of the system Recommendations Concessions, their fiscal impact 42

43 Fiscal planning Budgetary balance Starting in 2001 the central government considers structural income in preparation of the annual budget It is a balance adjusted by the effect of the economic activity cycle and the price of copper Formalized in the 2006 Fiscal Responsibility Law Concessions, their fiscal impact 43

44 Fiscal planning Fiscal balance % of GDP 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% -2.00% -4.00% e 2009p Superavit Efectivo Superavit Estructural Concessions, their fiscal impact 44

45 Fiscal planning Proper evaluation of the fiscal position requires consideration of future commitments In addition to annual flows, it is necessary to consider the stocks (debts) All fiscal obligations must be included, whether fixed or contingent Concessions, their fiscal impact 45

46 Outline Concession system The system s financial guarantees The system s fixed commitments Fiscal planning Financial management of the system Recommendations Concessions, their fiscal impact 46

47 Financial management of the system Requirements Sustainable in the long term Compatible with fiscal planning (Structural balance rule) Balance between concessions and provider indebtedness Monitoring by international organizations Concessions, their fiscal impact 47

48 Financial management of the system Management measures Disseminate information Rule of maximum fiscal commitment Management of contingent liabilities Management of project portfolio Permanent involvement of the Ministry of the Treasury in the projects and programs Concessions, their fiscal impact 48

49 Financial management of the system Disseminate information Publication of fixed commitments Calculation and publication of contingent liabilities Report on contingent liabilities publised by the Budget Office Concessions, their fiscal impact 49

50 Financial management Fiscal flow for guarantees 5,000 Percentiles 5 y 95 y Media de la Distribución de Probabilidad Estimada de los Flujos Anuales , Millons of $ , ,000-15,000-20,000-25,000-30,000-35,000 Flujo Medio Percentil 95% Percentil 5% -40,000 Año Concessions, their fiscal impact 50

51 Financial management Expected present value of guarantees Evolution of the estimated net contingent liabilities of the concessions system associated with the GMI Millions of pesos each year and as a % of GDP each year 250, % Millions of $ 200, , , % 0.21% 0.15% 0.18% 0.21% 0.14% 0.25% 0.20% 0.15% 0.10% % of GDP 50, % Año 0.00% Concessions, their fiscal impact 51

52 Financial management Control of contingent liabilities The total stock of guarantees is 3.72% of GDP The current value of expected payments is 0.14% of GDP If Chile s GDP is half of the trend, the current expected value is 0.3% The probability that the expected value exceeds 0.5% of GDP is less than 1% Concessions, their fiscal impact 52

53 Financial management Control of contingent liabilities Summary of government contingent obligations reported Percentage of GDP /1 Contingent liabilities Present value 2007 Present value 2008 Observations Pension system guarantee 1.75% 1.79% Estimated Concession system guaranteed minimum income 0.21% 0.14% Estimated Guarantee of debt of public corporations 1.21% 1.27% Maximum exposure Higher education loan guarantee 0.08% 0.18% Maximum exposure Lawsuits against the government /2 0.01% 0.01% Estimated Concession system disputes 0.23% 0.08% Maximum exposure Governmental guarantee of deposits 3.48% 1.40% Maximum exposure TOTAL 6.96% 4.86% /1 Estimated GDP for 2007 and 2008 as applicable /2 Annual value Concessions, their fiscal impact 53

54 Financial management Fixed commitments Rule of Maximum Fiscal Commitment Current commitments of the concession system Resources to be committed for projects Allowance for resources for future agreements regarding this projects, including contingencies Pending supplementary agreements Commitments associated with new projects identified but not yet opened for bid Concessions, their fiscal impact 54

55 Financial management Fixed commitments Rule of Maximum Fiscal Commitment Provision of resources for future agreements and expenses associated with those projects Determine budgetary availabilities considering the abovementioned total expense framework Finally, budgetary availabilities are combined with current and future commitments to establish the profile of resources that could be committed to concession projects Concessions, their fiscal impact 55

56 Financial management Fixed commitments Commitments of the concession system as a percentage of the budget of the Ministry of Public Works (1) Flows % 20% 15% 10% 5% 0% -5% Concessions, their fiscal impact 56

57 Outline Concession system The system s financial guarantees The system s fixed commitments Fiscal planning Financial management of the system Recommendations Concessions, their fiscal impact 57

58 Recommendations Monitor macroeconomic risks generated Make sound macroeconomic decisions Criteria of economic efficiency Consider the long and medium term Consider estimated flows, not expected flows Consider all costs involved Concessions, their fiscal impact 58

59 Recommendations Projects should be socially profitable Disclose all information: contracts, agreements, commitments, etc. Compare concession costs versus public financing Assess risk transfer Concessions, their fiscal impact 59

60 Recommendations Good base studies Realistic times Specialized advisory services Check & balance institutional counterweights Concessions, their fiscal impact 60

61 Concessions, their fiscal impact David Duarte Arancibia Budget Office Ministry of the Treasury April, 2009 Concessions, their fiscal impact 61

Contract Renegotiation: Chilean Case David Duarte Arancibia Budget Office Ministry of Finance of Chile Paris, France March,

Contract Renegotiation: Chilean Case David Duarte Arancibia Budget Office Ministry of Finance of Chile dduarte@dipres.gov.cl Paris, France March, 2009 Agenda Chilean PPP System Current regulation Some