Should the Government be an Equity Partner in Infrastructure Projects?

Every infrastructure project around the world needs one or more equity partners. This equity partner acts as an entrepreneur and takes all other decisions which allow for smooth completion of the project. In most cases, private companies that have considerable know-how and experience in the sector in which the project is being executed become equity partners. However, in many cases, governments also become equity partners in infrastructure projects. Whether or not the government gets any upside from doing so is debatable! In this article, we will have a look at all the arguments and counter-arguments, which are stated whenever the question of the government holding an equity stake in an infrastructure project is discussed.

Some of the common reasons given by the government to hold an equity stake in infrastructure projects as well as the counter-arguments have been explained below:

Reason #1: Sharing the Profits

Often it is argued that the government is the real driving force behind infrastructure projects. This means that the government takes all or most of the risk. However, when it comes to profits, a few handpicked companies in the private sector end up taking most of the profits. In order to avoid this from happening, the government can take a significant equity stake in the project. Hence, if there is a significant upside, the government will end up benefitting as well.

The counter-argument to this is also very convincing. This is because it is very difficult to forecast whether a project will actually be profitable later on, and hence, making huge investments when profitability is highly uncertain cannot be considered to be prudent. Also, private companies get an upside because they have control over the project. In the case of the government, they will only have money invested in the project. Most of the operational control related to the project will continue to remain with private parties. Hence, the government is unlikely to benefit by taking an equity stake. On the other hand, the government would be better off by taking a fixed payment, such as a lease in place of a partnership. The problem is that the lease amount should be decided on keeping the competitive market conditions in mind.

Reason #2: Control

In many cases, the government may think that a certain sector is strategic in nature. Hence, the government may try to retain control over the sector by maintaining an equity stake in key infrastructure projects. This may be done to stop the project company from using excessive force and resorting to profiteering. The government may control a sector by exerting control over the finances of the infrastructure company. Alternatively, it could also use sensitive information which is available inside the company to benefit the consumers and the sector as a whole.

However, this reason is also not very convincing. This is because private sector companies are careful when they enter into management contracts with the government. These companies ensure that their interests are not harmed. The governance structure is often set up in such a way that the interests of the private parties are not compromised. This is done by citing the fact that the government may have a conflict of interest, and it may end up making decisions that are politically motivated and may not be good for the company. After all, it should be illegal for one shareholder to benefit at the expense of other shareholders, even if that shareholder is the government. If the government wants to ensure fair competition in any sector, it would be better off creating efficient regulatory mechanisms instead of taking equity stakes in the project.

Reason #3: Conserving Bank Funding

Governments want to ensure that commercial banks do not take excessive risks by lending to extremely long term infrastructure projects. This is because banks receive funds using short term volatile deposits. If they lend money to extremely long term projects, they will face a timing mismatch between their assets and their liabilities. Also, if commercial banks lend huge sums of money to infrastructure projects, they will not be left with much money, which can be lent out to small businesses and other key sectors in the economy.

Once again, this is flawed logic because if the government’s only intention is to provide funding to the infrastructure projects, it should provide incentives for the private sector to invest in infrastructure projects rather than taking equity stakes which could then be mismanaged and could end up causing significant revenue loss to the government. Also, if the government issues bonds with funding these projects, it is also taking money out of the private market. An increase in the number of bonds issued will correspond with a decrease in the number of other investments made by the general public.

The fact of the matter is that governments tend to be inefficient when they spend money. These inefficiencies are only magnified when the government spends large sums of money to take equity stakes in complex projects. The reality is that every objective that the government may want to achieve via an equity stake can be better accomplished using a less-risky, less expensive alternative.

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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to and the content page url.

Infrastructure Finance