Lewis 2017). More generally, when the constraints on the executive are not stringent enough, the contract loses its value in mediating the relationship between the government and the private party, and hence makes the project more susceptible to distress.

The deviation of the annual depreciation rate from its long-run average—a surprise local currency depreciation—is associated with higher risk of distress. Irwin (2007) notes that exchange rate risk affects infrastructure investment in two ways. First, many infrastructure PPPs, such as those in power generation, use inputs priced in foreign currency. Second, given the insufficient local savings and underdeveloped local currency markets in most low- and middle-income economies, financing of long-term infrastructure projects most often relies on debt denominated in foreign currency, but the revenues of the operators are in local currency. The currency mismatch between revenues and costs can push the project company to insolvency very quickly, if the local currency depreciates sharply.

Occurrences of systematic banking and debt crises are associated with higher hazard rates for PPP projects. A systematic banking crisis undermines the ability of financial institutions to provide the financing that is necessary to sustain long-term infrastructure projects. A debt crisis can limit the government’s ability to fund PPP projects according to the terms of the contracts. It may also hinder the ability of the local private party to secure debt financing through the market and increase the cost of its outstanding debt, leading to early termination of PPP projects. Because of the longterm nature of PPPs and the high transaction costs of preparing, procuring and awarding them, both parties try to negotiate changes to the contract or some kind of compensation in response to macro-financial shocks. Early termination happens only if the parties cannot reach an agreement, hence the lag in the impact of macro-financial shocks.

# **4.2. Exposure at distress**

In general, governments are exposed to obligations from the debt and equity financing of an infrastructure project when the PPP is terminated. As the ultimate guarantor of the public infrastructure service, the government steps in to resolve the matter. As indicated in World Bank’s Guidance on PPP Contractual Provisions, the market practice in the event of a PPP contract termination is that both the lenders and the equity owners must be compensated if distress occurred without any fault of either party (World Bank 2019). Without such explicit or implicit guarantees, especially in emerging market and developing economies, private finance cannot be effectively mobilized.

In valuing the fiscal risks from early termination of PPPs, the exposure at distress due to each project is calculated using the debt and equity data in the PPI database. The PPI database provides the shares of the physical investment that have been financed through debt, equity or capital grant from the government. In the case of missing values, data was collected and when information could not be found, the missing values were imputed as discussed in appendix D.

The total debt used to finance the currently active 1,056 greenfield and brownfield PPP projects in energy, transport, and water and sewerage in South Asia<sup>16</sup> is estimated to be $218 billion and the total equity financing is estimated to be $77 billion. The average leverage ratio, at the time of

> 16 Excluding the projects which elapsed their imputed or observed contract period.

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