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Boosting Private Sector Confidence in Chinese Public-Private Partnerships

Since late 2013, the Chinese Central Government has been promoting and developing Public-Private Partnerships (PPP) to stimulate the economic growth. PPPs leverage private sector capital, efficiency, and innovation, while mitigating the pressures of local governments’ constrained budgets.

So far, progress has been slow. Among the 7,721 projects recorded under the official PPP Comprehensive Information Platform in China, only 21.7% of them had properly started by the end of March this year. As a result, the private sector lacks confidence in the PPP plan.

China PPP - Started Proj

Building private sector confidence is essential to promoting PPP models in China. To achieve this objective, several strategies should be pursued:

(1) Change the misperceptions of PPP from the government side;

(2) Create a level playing field for state-owned and private enterprises;

(3) Develop a more accessible and comprehensive financing system for the private sector; and

(4) Improve the regulatory and legal framework for PPP projects.

I. CHANGE THE MISPERCEPTIONS OF PPP

Currently, the public sector in China has two main misperceptions about the PPP model.

First, local governments cannot tell between the PPP model and the traditional public procurement model. The PPP model is seen as yet another financing tool that transfers debt leverage from the public sector to the private sector. They have long been accustomed to the traditional public procurement model, in which the public sector takes control of every stage of a project, while the private sector hardly takes any initiative. Therefore when it comes to PPP, the local officials continue to take a firm grip on the whole process of a project, leaving very limited choices and discretion for private investors. Second, many local officials mistakenly equate PPP with privatization of the public properties or services. Therefore, they stay suspicious of the PPP model and prevent private entities from participating in the projects. These misunderstandings have largely dampened private companies’ incentives to engage in PPP projects and their potentials to innovate and contribute when they are involved in the projects.

Institutions that take the lead to develop and promote the PPP model across the country should help officials at all levels of governments change their misperceptions and accurately understand the nature of these partnerships. They could: (1) conduct online training for government officials to learn by themselves; (2) hold regular forums, workshops, or meetings for them to communicate and learn from each other; and (3) edit and issue PPP manuals or guidelines for their reference. These methods will help government officials understand that, unlike traditional public procurement or privatization, PPP is an innovative model that leverages the respective advantages of public and private firms, and efficiently allocates risks between the two. The government should give sufficient discretion and trust to the private sector. 

II. CREATE A LEVEL PLAYING FIELD FOR STATE-OWNED AND PRIVATE ENTERPRISES

So far, the state has crowded out the private sector in PPP projects. For example, as of June 2016, among all the recorded contracted projects, the value of contracted projects involving state-owned enterprises has reached nearly 380 billion RMB (56 billion dollars), but the value of those projects that involve private firms has only reached 140 billion RMB (20 billion dollars).

China PPP - Contracts

State-owned enterprises are very special entities with an important role in China’s economy. When bidding for a PPP project, they have a number of competitive advantages compared with their private counterparts, including better access to banks. They dominate or even monopolize certain state-controlled sectors such as electricity, rail, and public utilities.  Furthermore, local governments are reluctant to cede their most promising projects to private investors because many officials are suspicious of private firms. Officials sometimes set very high standards, such as a large security deposits, licensing requirements, and various substantive or procedural barriers to make private companies’ participation in PPP projects difficult.

The dominance of state-owned enterprises in PPP projects has actually deviated from the very essence of PPP by failing to effectively utilize private capital. It is understandable that in certain strategically sensitive sectors, or for certain large-scale projects, state-owned enterprises may be the more appropriate partners to cooperate with. In principle, however, all levels of government ought to be instructed to create a level playing field for state-owned and private enterprises.

First, the government should consider relaxing market entry to private entities in traditionally inaccessible sectors. For example, the Guidelines on Deepening the Reform of State-owned Enterprises mentioned that in sectors such as oil, gas, electricity, railway, telecommunications, natural resources exploitation, and public utilities, the government could engage non-state players in projects, which are compliant with industrial policies and could facilitate transformation and improvement of industrial technology and skills.

Second, local governments should treat state-owned and private enterprises equally in PPP projects, eliminating the conditions and requirements that intentionally favor state-owned firms.

Third, governments should encourage participation by fully private business consortiums, and public-private consortiums. It would be easier for private firms to win in the PPP bidding process as part of a consortium, given the relatively limited capital and scales of each private firm when they compete alone. A consortium of state-owned and private enterprises could also take full advantage of the respective merits of these two kinds of enterprises. State-owned enterprises tend to have larger scales, more capital, and more familiarity with the rules and working styles of the government, while private firms tend to be more efficient and more innovative.

III. DEVELOP A MORE ACCESSIBLE AND COMPREHENSIVE FINANCING SYSTEM FOR THE PRIVATE SECTOR

One of the biggest challenges facing the private sector is financing, which is difficult and costly to obtain. Bank loans remain the main financing method for the private sector. However, a number of banks impose restrictive conditions on the private sector, including personal guarantees by shareholders, and mortgages secured against project companies’ assets. Furthermore, compared to the normal 6 to 8 percent rates of return in municipal engineering projects, the financing cost of the private sector already accounts for 8 percent of the total cost, and can be even as high as 12 percent for small private firms. This has held back the private sector.

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Several policy changes should be made to improve the financing environment for the private sector in PPP projects. First, the China Banking Regulatory Commission should instruct banks to eliminate unnecessary requirements imposed on private sector firms applying for loans in PPP projects, and to create financial products designed specifically for PPP private financing. Second, coordinating with regulators, such as the China Securities Regulatory Commission,China Insurance Regulatory Commission and the People’s Bank of China, will be key in diversifying financial methods and the composition of financiers.

Specific actions could include: (1) instructing financial policy institutions, such as the China Development Bank and the Agricultural Development Bank of China, to give more long-term, low-cost financing support for PPP projects, especially projects in strategically important fields such as public services, infrastructure, and environmental protection; (2) developing more government investment funds at all levels, including social security funds and insurance funds as a form of financial support, similar to the Chinese PPP Financing Support Fund; (3) improving the capital market system to provide more accessible financing; (4) encouraging private capital to be devoted to industry investment funds used in strategically important industries such as public services, infrastructure building, and ecological and environmental protection, and providing government support by subscribing to those industry investment funds; (5) boosting the development of bond and note markets.

IV. IMPROVE THE REGULATORY AND LEGAL FRAMEWORK FOR PPP PROJECTS

A final hindrance to private sector firms in entering PPP projects is the lack of institutional protection. Private firms are worried their contractual rights cannot be properly protected, especially in the case of government default. In the past, some private firms went unpaid for their work, sometimes finding themselves in debt. Government default usually occurs when the government changes its original plan for local development, either due to changes in leadership personnel or in the socio-economic environment. For example, in Hebei Province, newly appointed leaders reneged on the pledges given by their predecessors to a private environmental enterprise. In another case, when a company invested in a bridge-building project with a local government, the two parties agreed the city only needed one bridge. Several years later, when there was growth in car ownership, the government changed its plan to build another bridge, leaving the company watch its revenues from bridge tolls decline.

Against this backdrop, the current regulatory and legal framework needs to better protect the private sector’s legitimate rights under PPP contracts. The relationships between public and private sectors in PPP projects, including their mutual rights and obligations in relevant laws and regulations need to be clearly defined. There has been debate over the nature of PPP contracts, namely, whether the PPP contractual relationship should be defined as an administrative or a civil one. Given the disadvantaged administrative position of private firms, and the relatively weak implementation and enforcement mechanism of administrative law in China, the PPP contract should be deemed a civil contract between two equal parties, but the public sector retains certain privileges to change or terminate PPP contracts for the public good. For the latter case, it is understandable in a developing economy like China’s, municipal infrastructure changes quickly. In this scenario, laws and regulations should assure private firms remedial mechanisms, such as reasonable compensation, if the contracts are changed or terminated and the private firms end up not getting paid or fully paid. Laws and regulations should also provide sufficient dispute resolution channels to address potential conflicts, such as mediation, arbitration and litigation. 

V. CONCLUSION

Public-private partnerships present great opportunities to boost China’s economy and facilitate municipal growth during the current urbanization process. Engaging the private sector in PPP projects is the core of this model. Government officials need to truly understand, accept, and welcome private sector participation by changing their misperceptions of PPP and creating a level playing field for both state-owned and private enterprises. Furthermore, government actors can provide solid financial and institutional support for the private sector, by developing a more accessible and comprehensive financial system, and improving the regulatory and legal framework.

 

 


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