Public Private Partnerships in Hungary (Dr. Pál Csapodi, Secretary General of the State Audit Office of Hungary)

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1 1 st International Scientist Conference The Public Sector in the Contemporary State (Economy and Management Faculty of Bialystok University) Bialystok (Poland), October 2008 Public Private Partnerships in Hungary (Dr. Pál Csapodi, Secretary General of the State Audit Office of Hungary) In general terms, both internationally and nationally the cooperation between the public and private sectors appears in four main areas of market practices. These are: - Outsourcing - Public-Private Partnership (PPP) - Voucher system - User Charging From among them, the present paper is going to address PPP, more specifically its aspects in Hungary where this practice has started only recently and has been mushrooming ever since. I plan to examine the issue from the aspect of the State Audit Office of Hungary because, as the supreme audit institution of the country, this office has already gained specific audit experiences on PPP. The cooperation between the public and private sectors is using a vast amount of public funds, and as such is posing a new challenge for supreme audit institutions (SAIs) both theoretically and in terms of the practical implementation of the audit. INTOSAI (International Organization of Supreme Audit Institution) holds the view that SAIs are to play a vital role in identifying how efficiently partners involved in the cooperation are managing the risks arising under the respective PPP projects. In addition, INTOSAI reminded SAIs and the professional community of several risk factors they may face when auditing new types of business relationships. The PPP practice in Hungary The process of involving private capital in the provision of public services indicates that those PPP arrangements gained ground in Hungary in a relatively short time, which tried to present institutional forms actually operating with the utilization of public funds, as non-public, as not being part of the mainstream public sector operations. These practices do not qualify as conscious PPP schemes, since the related experiences came to Hungary only in 1999 and I will attempt to present Hungary s first experiences with partnerships between central government and private sectors on the basis of decisions adopted on major development projects and their implementation process. From among them I will address three projects (Budapest Sport Arena, Palace of Arts, and First Phase of building motorway M5) and describe the lessons learned in the course of the implementation process.

2 Budapest Sports Arena (BSA) The initial idea was to build the BSA to replace the sports facility that was destroyed in a fire, in a classic PPP arrangement. A private sector partner (as project owner) would have operated and financed, at least to 50 %, the facility. In return, the Hungarian State would have paid a service fee for a 20 year period. As the government at that time did not want to undertake a financial commitment for 20 years, the project was implemented in a different construction. The SAO examined the whole project in autumn 2003, and despite of not having objection from professional point of view, the audit found that the foreign partner had 75 % and the Hungarian State only 25 % of the decision powers at the joint venture enterprise set up for the implementation of the development project. However, such distribution of the shares did not ensure the enforcement of the central government s interest. According to the SAO findings, the project could have been implemented under a classic PPP scheme, but due to several circumstances (pressure of time, high-quality implementation) and more specifically the lack of practical experiences and professional capabilities in respect of PPP, it was not possible to make use of the benefits of a classic PPP scheme for the central government sector and the general public. Palace of Arts Preparation and implementation of this project was launched upon a private initiative. Apart from the lack of a multifunctional cultural facility and of a concert hall that meets international standards, this cooperation between central government and private sectors was driven also by the possibility to achieve short term savings of public funds and to ensure the innovative involvement of enterprises. However, the involvement of the central government sector in the project was not substantially considered. That is, neither cost analysis nor preliminary study (based on economic calculations) was developed. Originally, the contract assigned the total risk of the project to the investor. In return the Hungarian State agreed to pay off, in instalments, the costs in 10 years after opening the facility. This model is nothing but a financial lease, that is, with the central government sector giving full guarantee for the project and the private sector investor doing the project on credit. This fact was supported also by a finding of the SAO, stating that to achieve this goal the budget act provided collateral security in the amount of HUF 52 billion. The contract on project implementation did not include how to share the risks arising under the PPP cooperation for the project as a whole. Thus, this model failed to comply with the triple principle applicable to PPP development projects, which requires the investor to assume the implementation, availability, and operational risks. The SAO has recently finished its audit on the implementation of Palace of Arts project, covering the period from 2001 to The main problem identified by the audit was the lack of a market survey, which would have been necessary for 2

3 the project implementation. The audit found that economy and efficiency in the project implementation were adversely influenced by the preparation being insufficient in terms of well-foundedness. Furthermore, the changes in the functions of the facility and in the funding arrangements, as triggered by the insufficient preparation, were also setbacks for economy and efficiency. In its relevant audit report, the SAO recommended the government to adopt regulation on a single system of procedures and also cooperation rules for development projects implemented under a PPP vehicle. First Phase of building motorway M5 Due to the growing volume of heavy-, and passenger traffic in the direction of the Southern borders of Hungary, the demand and expectation arose in the Hungarian society for the construction of motorway M5. The government signed the concession contract in May Based on this contract constructions works started in parts. The motorway has been completed up to the towns of Kecskemét and Kiskunfélegyháza in 1997 and in 1998, respectively. In accordance with the contractual stipulations, the concessionaire collected toll on the sections already opened up for traffic. As the traffic radically declined due to the high toll, compensation had to be paid from the Hungarian state budget for the shortfall in revenue (and for the profits) on the basis of the contract. An assessment on the first phase found that this development project was rather an unfavourable example for the central government effort to involve private capital. Although the private sector provided the funds for the project and also agreed to arrange for the operation with all the related financial burdens, it is indeed for the central government sector to assume the demand risk. The SAO audit report addresses issues of the motorway M5 construction contract and agrees with the legal opinion in respect of the initial contract. The referred legal opinion states that the consequences of any legal actions by the central government with the goal to terminate the concession contract are hardly predictable would turn out only after a definitive court verdict had been adopted. That is, the contract included some one-sided terms, absolutely for the benefit of the private sector partner. As indicated by the above examples, the first attempts in Hungary to apply the PPP model did not work out well. It is quite on the contrary, we could rather learn how one may not start with a new practice of development projects, like the present one. Evaluation on the implemented and ongoing PPP projects The budget bill for the year 2005 was the first occasion when the PPP scheme was used deliberately by the government on the basis of former government decisions and parliamentary resolutions. According to the bill, the net present value of development projects to be implemented within the framework of PPP 3

4 was above HUF 460 billion. This amount was planned to be used for continuing the motorway M5 construction, completing the first phase of the motorway M6, building residence halls and prisons. The estimated value of PPP projects was nearly HUF 700 billion in the 2006 budget, equalling to 3 % of the Hungarian GDP in the given year. The respective estimated value for the 2007 projects shows a minor decrease in comparison to the previous year. From among the major PPP projects covered by the 2006 and 2007 budgets, I am going to introduce the development trends and highlights of those, which the SAO could subject to its audit activity. For this introduction I am using the criteria from the relevant SAO audits. The projects in question already have been completed or are ongoing or under preparation. They include the continued construction of the motorway M5, a prison building construction projects and education projects. Motorway construction By learning from the adverse experiences gained from earlier motorway construction projects, the construction of the first phase of the motorway M6 development project was implemented on the basis of a concession contract and a PPP funding contract, as required by a parliamentary resolution. The project s estimated present value was HUF 117 billion. The concession period commenced at the end of 2004, its total term is 22 years. The completed sections were opened up for traffic in summer The annual activity report of the SAO in 2006 addressed issues regarding the comparative audit of the different funding arrangements of motorway development projects. The SAO recommended the government that preliminary calculations on economy should be carried out on the basis of the Ministry of Finance s relevant model for any involvement of private capital, especially in case PPP investments. Prison building As part of the comprehensive audit of the Ministry of Justice chapter, the SAO examined how the prison building construction projects to be implemented as PPP was prepared in professional terms. The audit report found that the mitigation of over-crowdedness in correctional centres and the goal to achieve a better compliance with the relevant EU requirements posed a financial demand for Hungary, which exceeded the capacity of the system of public finances. This was the reason for the 2004 government decision to build two correctional centres in PPP cooperation. The SAO report assessed several areas of the project as risky because preparation works started on the grounds before having definitive regulations on the 4

5 relevant issues. The SAO report called for an urgent elimination of the regulatory shortcomings and turned the public attention to the considerable additional risks for the central government sector that might arise already in the preparation phase. As regards the efficiency of the public services in question, the international experiences related to the construction of correctional centres as PPP investment (mainly from the UK) proved to be favourable. This may give rise to the hope that with an adoption of such experiences, PPP projects could become more successful and efficient also in Hungary. Education projects The Ministry of Education and Culture made considerable efforts under the Hungarian Universitas Programme to implement programmes in the areas of education, Research and Development and residence hall construction. In this context, in the period , with the involvement of private capital, the government set the goal to create living accommodation for 10,455 new students in residence halls and reconstruct 20,000 houserooms in dormitories. As part of its 2007 annual audit programme, the SAO carried out an audit with the goal to examine the preparation phase of the referred project and the wellfoundedness of the project s legal background. The audit concluded that the development measures were justified but the objectives from the relevant government decree were not supported by a strategy on residence halls or by any kind of a comprehensive feasibility study. This programme was only subsequently integrated into the higher education competitiveness programme. The individual development measures were not supported by regional educational plans or demographic estimations. The former institutional development plans provided the basis for the development measures, but did not include a separate section for residential hall development. PPP projects with the participation of the local government sector The resources provided from the central state budget for funding the intended local government development projects and the own resources of local governments are generally not sufficient. Due to the financial position of local governments and the heavy debts of some of them, their interest in PPP investments is on the rise, with a view to implementing PPP or PPP-like projects implying long-term financial commitments with the involvement of the private sector. In this respect it is a major problem that the present statutory regulation concerns only PPP projects implemented from the central budget. The SAO could not even obtain information on PPP projects of local governments, unless the central budget provided incentive subsidies for them. Audit experiences of the SAO supports the fact that even before the dissemination the propagation of the PPP concept, local governments and the private sector have already concluded contracts with a structure and content similar to those of the PPP scheme. The relevant SAO audit findings were very 5

6 much similar to the findings on central government sector PPP projects, that is, the long-term PPP decisions were not preceded by efficiency investigations or comparative analyses. It was indicative of the situation that the conclusion of these contracts by local governments was driven by their lack of resources for developments and their incapability to raise loans in consequence of having reached the debt service limit of local governments. In the future Hungary has to count with the PPP investments continuing to gain ground in the local government area, because sectoral legislations are assigning more and more public services to local governments, which have only limited resources (both central budget resources and own resources) to provide them. Resources for development projects may come from various sources. Apart from EU-funds, the different loans with preferential term and central budget subsidies can also play role. PPP and the audit activity of Supreme Audit Institutions The new ways of spending public resources require the introduction of new techniques in the audit activities carried out by Supreme Audit Institutions (SAIs). This challenge is posing new tasks for the audits in terms of theory and practice alike. That is, two basic requirements can be specified for the audit activities carried out by Supreme Audit Institutions on PPP projects. According to the practice of SAIs in developed countries, apart from traditional financial audit activities, the qualification of the reliability of accounts and the enforcement of transparency, control activities focusing on performance and efficiency, as well as facilitating economic evaluation and decision-making are becoming priority. On the other hand, the compliance with rules is only the minimum requirement for the operation of the system of public finances without of which performance and efficiency cannot be interpreted. On the basis of comparing the national experiences gained so far to the international experiences and the recommendations of Supreme Audit Institutions, one can emphasize that to achieve a more successful implementation of PPP investments in the future it is an imperative necessity for the central government agencies, which are involved in the decision-making, to have unambiguous regulation on the procedures and rules connected with PPP, both in the area of the central budget and in the area of the local governments. 6

7 Bibliography: 1. The general government sector from a new approach. Financial cooperation between government and enterprises (By Zoltán Agg and Gizella Csonka, in Pénzügyi Szemle ( Public Finance Quarterly ), 2003, issue 3) 2. PPP projects in the field of the local government sector. Mid-term review. Studies on how to further develop the funding system of local governments (By Ildikó Koncz, edited by András Vígvári, Budapest, 2005) 3. PPP regulation in lacking (By János Fónagy, in Pénzügyi Szemle ( Public Finance Quarterly ), 2006 issue 3) 4. Competitiveness and Public Finances (By Árpád Kovács, in Pénzügyi Szemle ( Public Finance Quarterly ), 2005, consolidated issue) 5. Hungarian audit experiences on development projects realized with private sector involvement (By Gusztáv Báger and Zsigmond Bihary, Brasilia, 27 September 2005) 7