# **1 - Introduction**

This paper focuses on the ‘handshake’: the decision by public and private sector agents or ‘partners’ to formalize a Private Sector Participation (PSP) project. We use data on the number of projects signed by country in the water sector in the 1990-2004 to analyze the determinants of deal frequency across countries. Building on the literature on the determinants of PSP investment volumes and on work done in the field of institutional economics, we test the importance of institutional, macroeconomic and ‘need’ characteristics of countries on their propensity to sign PSP deals using a count outcome regression model. The analysis employs data from a new database of PSP in Water and Sanitation (“WATSAN”) for a sample of 460 signed PSP projects in water and sanitation in 60 developing countries. It reveals that national-level institutions are a significant determinant of the number of deals signed in each country.

In order to assess whether PSP is a viable and desirable approach to utility service provision, it is necessary to examine each stage in the project cycle, from its conception through its implementation. In this paper, we look specifically at an early stage in that process: signing the contract. This analysis contributes to an understanding of the determinants of PSP contract signature in developing countries in the water and sanitation sector. The findings may also be applied to other utility sectors.

PSP in utility sectors has attracted a great deal of interest in the academic and policy literatures. Several authors have analyzed determinants of investment volumes under PSP contracts in the telecoms and power sectors (Henisz and Zelner 2001; Henisz 2002) but no large sample study of this kind has been conducted for the water sector as sufficient data are not available. The analysis of other sectors points to the significance of judicial and political institutions in determining investment volumes. Other authors have looked at the welfare outcomes and efficiency performance of PSP projects in cross-country empirical work and through case studies (Abdala 1996; Alcázar, Abdala et al. 2000; Alcázar, Xu et al. 2000; Ménard, Clarke et al. 2000a; Ménard, Clarke et al. 2000b; Shirley, Xu et al. 2000; Birdsall and Nellis 2005). This literature also points to the importance of the institutional context. PSP performance has also been examined from the point of view of the firm. Estache and Pinglo (2004) and Sirtaine et al (2004) find that returns have not been commensurate with risks in utility PSPs.<sup>1</sup> Finally, interesting empirical work has recently been undertaken on the renegotiation of contracts using data from concessions in Latin America (Guasch 2004). The authors find that renegotiation is extremely common in the water sector, with 74 percent of contracts being renegotiated. On average, water projects were renegotiated within the first two years of the contract.<sup>2</sup> This paper is distinct from the existing literature in its focus on the initial agreement on a PSP contract between the government and firm. This stage in the life-cycle of projects has not yet been addressed in the literature and allows us to make full use of the WATSAN dataset. Given our focus, we do not address directly the determinants of investment volumes by the private party. Similarly, the performance of PSP projects and the frequency of renegotiation are not central concerns for the issue that we examine in this paper.

The WATSAN database was assembled by the authors for the purposes of this research as existing datasets on water PSP are incomplete in important respects. In particular, WATSAN has extensive coverage of projects involving local or regional investors as well as international investors. Local

> 1 Estache & Pinglo (2004) find that, for a sample of 120 PSP projects in developing countries from 1998-2002, the cost of equity (COE) exceeded the return on equity (ROE) in all years, for all sectors and all country-income groups. For the water sector, ROE were negative in two years (1999 and 2002) while COE stayed close to 10 per cent throughout the period. Sirtaine et al find that ROE rates in the water sector have been highly volatile from 1990-2001 and are lower on average over this period than in the transport, telecoms and energy sectors.

> 2 Guasch’s analysis of determinants of renegotiation uses a sample of 1000 concessions. For comparison, the rate of renegotiation is 54.7% for transport, 9.7% for electricity and 30% for all sectors.  He finds the following factors significantly raised the incidence of renegotiation: competitive bidding, price-cap regulation, contract award based on the lowest proposed tariff, contracts containing investment requirements and when a regulatory agency was not in place. The nationality of the concessionaire, macroeconomic shocks, political cycles and levels of corruption were also found to be significant.

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