11.1 The Process of Analyzing Fiscal Feasibility (affordability)

The first step in performing the fiscal feasibility exercise is to identify the liabilities assumed by government, at least on a yearly basis, for the entire duration of the contract.

There are two types of commitments that must be fully acknowledged in this identification: the direct liabilities and the contingent liabilities. To estimate contingent liabilities is a complex matter that may be approached by various methods which have been explained in chapter 2.

The exercise to assess the ability to accommodate the project within the long-term budget may be done from three different perspectives. Each includes specific tests to be conducted by the project team and will be presented below.

• Comparing the cash flow of commitments to the government’s total projected tax revenues;
• Comparing the cash flow of commitments to the contracting agency/sector projected budget appropriations; and
• Assessing the compliance with eventual overall budgetary limits and constraints.

The first exercise is a financial comparison between the contract liabilities and the total projected tax revenue per year of the contracting government. Typically, it demands a projection of tax revenues for the duration of the PPP contract. Some financial reports by the government might contemplate a medium-term projection (three to four years). A reasonable simplifying technique is to assume the growth rate of the subsequent revenues equal to the gross domestic product (GDP) growth rate. This comparison reveals the relative commitment of the total estimated tax revenues, and outputs a yearly percentage value.

The second exercise is a comparison between the commitments assumed and the fiscal budget assigned per year to the contracting or paying agency. This comparison should clearly indicate the availability of budgetary space to accommodate the direct liabilities, as well as the provisions required to address the contingent commitments.

Some countries have commitment-based budget systems (or obligations-based appropriations) in which the budget incorporates, at the moment of congressional approval, all the expenses to meet a specific program independently from its duration. In this case, the sum total amount of direct liabilities, and the value of the most likely case of contingent liabilities, should fit within the approved budget. Much more common, however, are the cash-based or accrual-based budget systems, in which yearly sums are projected and need to be incorporated in the agency expenditures of that year, either from an accrual or a cash perspective.

Most countries only consolidate medium-term budget systems of a three or four year time horizon. These do not effectively capture the commitments in PPPs because not only are there later long-term liabilities, but they also generally commence after the asset is built. This can happen many years after the appraising exercise is done. Thus, the valid budget available during the appraising exercise needs to be adapted in order to allow a meaningful affordability analysis. This generally demands an estimate of the agency or sector’s budget for the period of the PPP contract. A common reference is the projected growth rate of GDP applied over the last budget value available in the medium-term budgetary framework[35].

Again, the exercise outputs a percentage value comparing the liabilities with the agency’s estimated budget for each year during the contract’s life. There is also no threshold that is internationally recognized as good practice because the capital expenses of agencies vary significantly, and sectors might have a higher or lower propensity to invest. Traditionally procured infrastructure projects can consume budgetary space similarly to PPP projects, especially in accrual-based budgets, but also in cash-based budgets when debt is repaid from the agency’s own budget. Thus, the total commitment with infrastructure policy or with unmanageable budget appropriations should be considered when a recommendation for the final approval is produced as a part of the appraisal exercise.

The third affordability perspective is to identify specific regulatory limitations. Many countries create caps or limits for PPP liabilities. The United Kingdom, for example, created several limits of liabilities depending on the contracting agency. Several Central American countries impose limits to commitments as a percentage of their projected GDP. Those caps, ultimately, aim at providing objective measures of fiscal feasibility and attempt to limit fiscal exposure to PPP commitments. However relevant they are, they cannot replace a comprehensive analysis of affordability because they tend to focus on a formal and one-sided dimension of the problem. Brazil, for instance, sets a limit under which sub-national government contracted PPP commitments are not to exceed 5 percent of the total yearly tax revenues during the projected period of ten years. However, it only captures direct liabilities, and no cap or limit is officially imposed for contingent commitments.

In summary, the main tests of affordability that need to be conducted are listed in box 4.10.[36]

An effective affordability assessment must address all the issues mentioned above in order to promote a recommendation that prevents excessive fiscal exposure to risk and long-term expenditures with attendant undesirable effects on governmental finances.