7.7 International lesson for managing affordability risk

Even where the private sector bears this risk, the public sector can work to mitigate it throughout the planning stage. The impact of the risk, should it materialize, will be substantial. The government can mitigate this risk during the project preparation stage by making good-faith efforts to deliver a project that is well structured and financeable. Additionally, governments can evaluate whether the project will require credit enhancement in the form of guarantees to mitigate this risk and whether such instruments are appropriate. In many cases, guarantees may not be appropriate or may become too costly for the public sector to bear.

If the private partner is unable to reach financial closure, then the government has lost several months, if not years—plus precious financial resources— preparing and completing the project with little to show. If a preferred bidder cannot reach financial closure, the government is forced to make a choice among retendering, restructuring, or canceling the project.

Affordability

BOX 7.7

In principle, either the private sector or the government can assume affordability risk; however, careful consideration must be given to who should bear it and the impact on the project should the risk materialize. The government is best placed to assume this risk when the price elasticity of demand is high. When customers are less price sensitive, the private sector can bear the risk. box 7.7 presents a lesson learned for managing affordability. For more guidance, see ITDP (n.d.) and World bank (2002). Whoever bears the risk must, early on, assess the willingness of users to pay for the new service and verify that the willingness and ability to pay align with expected costs and revenue requirements. Furthermore, while conducting its own financial analysis, the government would do well to test a project’s financial viability, given changes that could require a tariff increase. In markets where governments choose to subsidize services as a matter of policy, the government must also evaluate its ability to sustain subsidy payments to the operators and test the sensitivity of the subsidy requirements to changes in costs and demand. The conditions required for the private sector to bear the risk completely, which may be a viable model in mature markets, include (a) a contract that has clear tariff adjustment mechanisms and formulas or (b) an independent and effective regulator that can approve tariff adjustments quickly to respond to shocks. A third option exists in which the parties share the risk using a minimum revenue guarantee mechanism (APMG International 2018g). under such an arrangement, the government guarantees the private party a minimum amount of revenue—usually enough to cover capital costs, operations, and debt service—in International lesson for managing exchange for the private sector accepting more reveaffordability risk nue risk. As a tool to maintain affordability, a minimum revenue guarantee can enable the private party to • A mechanism to modify payments to operators absorb temporary reductions in farebox revenues. and tariffs if revenues fall short of or exceed If the government is considering providing such a expectations is a good way of sharing upside and guarantee, it might also consider sharing the upside of downside revenue risks (Metropolitano). the project in case the project achieves returns above expectations.