The virtues of going for PPP led projects is clear enough for everyone. Making it work is about the right balance. Image Credit: Reuters

The skylines of major GCC cities are marked by superlative structures and feats of engineering; yet infrastructure development across the region is not without challenge. For the Gulf to reach its potential and continue blazing architectural trails, the infrastructure development model requires diversification and policy changes.

With investment at its highest level ever, the time for action is now. From Riyadh to Manama, these are not tentative proposals, foundations have been laid and blueprints will spring to life in the coming five to 10 years.

So, what’s the problem? One might ask. Against a backdrop of exciting developments and heavy investment, it can be hard to see where the weaknesses lie. That in itself is part of the issue: those in charge of shaping the cities of tomorrow often don’t see the problems themselves.

The problem

Globally, infrastructure development has typically been undertaken by the public sector. Yet the government machine is not always the most efficient operator, sometimes resulting in excessive project costs, delays, and opportunities lost. Of course, there are notable exceptions, such as Singapore and Dubai (as efficient as private entities) but worldwide, projects run by the state tend to cost more, waste more, and deliver less. In other words, for the price of running two bridges, the public sector will typically run one.

Why then, do governments take on the responsibility for developing roads, utilities, and other mega-projects? First, the initial financial outlay on infrastructure projects is immense, and the returns can be a decade – even two – in the making. Second, those returns are often indirect, taking the form of job creation, GDP growth, or tax revenue.

For national governments it makes perfect sense, but private enterprises simply can’t afford to wait tens of years to make back their money and indirect returns just don’t make for a viable business.

The bottom-line: for the private sector, incentives are in short supply when it comes to government-run projects, and it’s a problem exacerbated by the unfavorable terms. Governments have historically worked on the assumption that private companies need the public sector more than the public sector needs private companies. In the process, they have burdened businesses with the lion’s share of risk and financial responsibility, often to their own detriment.

But there is good news. The solution to the problem is within reach – and it lies in a revamp of the public-private partnership (PPP). What will truly make the region’s infrastructure ambitions a reality is a potent combination of public sector funding and private sector efficiency.

Thomas Kuruvilla, Managing Partner, Arthur D. Little, Middle East
Time and cost overruns need to be carefully managed for PPPs to have their best shot at success. Image Credit: Supplied

The solution

It goes without saying that no two countries are the same, but there are some fundamental principles that can be applied region-wide to make public-private partnerships the key to unlocking the infrastructure potential of the future.

Put the right party in charge of risk

In any project, if the wrong party is tasked with addressing the risks, then the overall project cost will rise. For example, if the risks associated with currency exchange variation or oil price fluctuation are put on the private sector, then the private sector will increase its costs considerably to absorb them. By contrast, the public sector is better placed to manage such risks and address them much more cheaply as a result – reducing the overall cost and increasing project viability.

Guarantee the revenue

It is important for governments to guarantee minimum appropriate revenue to the private sector. For instance, in the case of a public-private partnership to build a toll road, the private company cannot not be asked to guarantee the traffic that will pass through.

Instead, the government should estimate the number of vehicles, and if the real number falls short, it should pay a sum to the private sector partner. This might sound like a bad deal for the state, but the opposite is true. After all, if the public sector passes the responsibility on to private enterprises, they will increase – even double – their costs.

Obviously, if the public sector is guaranteeing minimum revenue, they will also then ask for a higher share of the upside/profit – which is fair. In summary, it is about selecting the right PPP model, with the right guarantees or returns allocated to the right party.

Introduce regulations that reassure

With infrastructure development projects often running for 10, 20, or even 25 years, the private sector can be left feeling uneasy about the implications of potential leadership change over time. To quell this fear, governments must give confidence to the private sector that their commitments will be honored.

This can be achieved through robust regulations, insurance policies, and a change in mindset that will leave companies assured. The example of India’s toll roads illustrates what can happen when such reassurance is absent. The Indian government cancelled contracts as the revenue to the private sector turned out to be three to four times higher than expected. As a result, the private sector is now hesitant to enter into PPPs for toll roads in the country.

A case in point

Last year, Saudi Arabia worked to understand why PPPs had previously failed in the kingdom and began developing policies and frameworks to set it on course for success. Amongst the outcomes has been an updated by-law designed to support what now counts as the most active PPP market in MENA.

Saudi Arabia has announced 18 projects to date, with a combined value of $42.9 billion – and more are likely to follow as the government strives to realize its economic diversification ambitions. In fact, PPPs form a key component of Saudi's National Transformation Program, which aims to increase the percentage of private sector investment from 40 per cent of GDP in 2016 to 65 per cent by 2030.

The state-led approach to infrastructure investment might be flawed, but with a concerted effort to readdress the public-private balance, the potential is limitless. As a first step, the onus is on the public sector to extend a hand – and much needed incentives and guarantees – to private businesses. After all, the benefits of good infrastructure far outweigh the little extra required to incentivize the private sector to build it.

In the long-run, a holistic plan to boost private-sector participation will reap greater returns for countries the world over than any short-term approach can offer. A little leniency can go a long way: give just a bit and the whole economy will gain a lot.