Obinna Chinewubeze, PhD student at ESSEC Business School, shares research that explores the relationship between private firms and government agencies in the power sector.
By CoBS Student Editor Kunal Ganorkar from an interview with Obinna Chinewubeze
Public Private Partnerships in emerging economies
Public sector projects have always been funded through taxation or through public funds which have been created for such purposes. However, of late, this trend has become more of a ‘private’ affair, so to speak. With companies like Google, Apple and Reliance possessing resources outstripping those of some countries, governing bodies have become all too aware of the powers of these entities. As such, private investment in public sector activities is at an all-time high – especially in the energy sector. Such special relationships are dubbed PPPs, or Private public partnerships.
In India in particular, the solar power sector provides a good example of this type of partnership, wherein it is common practice now to contract renewable power generation to private companies through a bidding process. At first glance everyone seems to benefit – public institutes gain excellent operations and efficient management of their resources, while private institutions develop political ties and instate lobbies to negotiate profitable deals for themselves. But the outcomes of these PPP relationships can go both ways, with private firms sitting on either side of the ‘profitability’ table.
If all goes well in an emerging economy using PPPs, in the long-run firms are able to enjoy a healthy profit. But when things go sour, they really curdle. A recent account by Meera Mahadevan talks of political interference in the utilities market of West Bengal that led to power generation firms losing nearly $57 million.
Caught on the hop
On more than one occasion, losses are a result of the adverse change in policies in order to support the political ends of respective political parties. Often, the ruling party in the government mounts pressure on power producing firms to renegotiate tariffs, despite having already signed a pre-negotiated agreement with them. This can happen for some reasons:
- Firstly, since political officials are not permanent officeholders, the benefits derived through firms’ political ties may not survive beyond the ruling party’s tenure.
- And secondly, since the political office-bearers have the objective of getting re-elected, they act unpredictably when the interests of the private firms get in the way of their chances of re-election.
In the solar energy sector, the most cited reason for forced renegotiation is the gradual reduction in the cost of producing solar energy over the past few years. In the Indian context, improvements in technology have made recent contractual tariffs much lower than what they used to be a few years back. Seeing this, state utilities tend to force their private counterparties to reduce prices, without considering that the firms involved already incurred sunk costs based on existing technology at the time the contract was signed. The implication is that such firms might not be able to recover the cost sunk over the coming years, as typical solar energy projects span 25 years. As is practice, firms pre-borrow money and make commitments in advance based on prior agreements and tariff negotiations – something that puts them in an unfortunate position.
To tackle this underlying risk in investing in emerging economies, firms tend to quote a higher price as a buffer when negotiating with governments. The escalated pricing in turn trickles down the chain to the end-consumer, digging deeper into their pockets and eventually begging the question of how to put an end to such a trend.
In the eyes of the law
To understand this phenomenon, Obinna Chinewubeze, together with ESSEC Prof. Srividya Jandhyala, has been studying the solar power sector in India to understand the impact of the quality of the regulators in the country and on the investment decisions of private firms in the host nation. The study is based on the contractual tariffs that solar power producing firms accept when supplying electricity to state utilities in India. Chinewubeze suggests that the credibility of the regulatory institutions may have a role to play when firms decide the valuation of their bids.
In his study, Chinewubeze points out that the lack of strong formal institutions for regulation may give room for adverse government intervention which can lead to expropriation of involved firms. To potential investors, this lack of credibility is likely an indication of risk, and they take it into account by adding a risk premium to their bids. The eventual outcome is an ‘inflation’ in the prices that the firms propose when bidding for the contracts. Moreover, this also deters firms from investing in such countries.
To tackle this, governments can signal credibility by delegating decision-making to regulators – entities authorised to use legal tools to achieve policy objectives which are standalone from the government entity. When these regulating bodies are both independent from governments and are capable of keeping the government’s discretion in check, firms show a tendency to undercut the pricing of their services and generally bid lower.
Chinewubeze believes that the quality of regulatory body has a positive impact on the profitability and sustainability of private firms in such PPP relationships. This finding can be used to create policies that prioritize regulator quality.
A win-win for all
For now, Obinna Chinewubeze sees no end to these unfortunate occurrences between firms and governments. He feels the need to address this issue has become even greater with the immense progress shown by economies like China, India and Singapore.
His hope would be for the topic to stay relevant to researchers and scholars long enough for there to be a substantial reform in emerging markets – something that would result in more prosperous PPP relationships, and a less burdened end-consumer.
- Link up with Obinna Chinewubeze via LinkedIn
- Discover the ESSEC PhD programme
- Visit the ESSEC Business School website
- Read other ESSEC features articles on public policy and arbitration.
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