Closing the Republic of Korea's infrastructure gap through sustainable public-private partnerships, 1994–2005

This case study reviews the evolution of public–private partnership (PPP) policy in the Republic of Korea in chronological order and identifies the lessons learned. It describes the background of the country’s innovative infrastructure financing scheme in the early 1990s and the policy measures that were used to promote private investment in the wake of the Asian financial crisis in the late 1990s. Facing an infrastructure gap, the Korean government passed the PPP Act (the Act on Promotion of Private Capital into Social Overhead Capital Investment) in 1994 to expand its fiscal space by inducing private investment in infrastructure development. However, the new act was not very effective at this task, mainly because of the lack of detailed rules and regulations surrounding the new investments, the limited capacity of government officials, and the weakness of Korean financial institutions. It was the amendment of the PPP Act in 1999, in the wake of Asian financial crisis, that provided the driving force to the PPP market, enabling a sizable number of PPP projects to begin. Adding to the existing tax incentives and land acquisition privileges for the special-purpose vehicles (SPVs) formed to implement PPP projects, the government provided substantial support, including a new risk-sharing scheme, the MRG (Minimum Revenue Guarantee) clause, to mitigate project risk for SPVs. The government also encouraged unsolicited PPP proposals, thereby allowing private companies to develop projects in advance of government planning. The new risk-sharing scheme of the MRG clause was effective at quickly expanding the PPP program. However, the MRG policy went on to pose long-term challenges to the government’s fiscal sustainability. The government had to accept fiscal liability for low demand for PPP projects and pay substantial amounts of money through the MRG clause. Also, both users of the new infrastructure and politicians criticized the high tolls charged. As concern rose about the fiscal sustainability of PPPs, the government revised the PPP Act again in 2005, and a series of new policies were introduced to strengthen fiscal discipline in PPP implementations. A rigorous VfM (Value for Money) test, introduced as a due-diligence measure, now had to be met before a project was designated as a PPP. Facing an infrastructure gap, the Korean government passed the PPP Act (the Act on Promotion of Private Capital into Social Overhead Capital Investment) in 1994 to expand its fiscal space by inducing private investment in infrastructure development. However, the new act was not very effective at this task, mainly because of the lack of detailed rules and regulations surrounding the new investments, the limited capacity of government officials, and the weakness of Korean financial institutions. It was the amendment of the PPP Act in 1999, in the wake of Asian financial crisis, that provided the driving force to the PPP market, enabling a sizable number of PPP projects to begin. Adding to the existing tax incentives and land acquisition privileges for the special-purpose vehicles (SPVs) formed to implement PPP projects, the government provided substantial support, including a new risk-sharing scheme, the MRG (Minimum Revenue Guarantee) clause, to mitigate project risk for SPVs. The government also encouraged unsolicited PPP proposals, thereby allowing private companies to develop projects in advance of government planning. The new risk-sharing scheme of the MRG clause was effective at quickly expanding the PPP program. However, the MRG policy went on to pose long-term challenges to the government’s fiscal sustainability. The government had to accept fiscal liability for low demand for PPP projects and pay substantial amounts of money through the MRG clause. Also, both users of the new infrastructure and politicians criticized the high tolls charged. As concern rose about the fiscal sustainability of PPPs, the government revised the PPP Act again in 2005, and a series of new policies were introduced to strengthen fiscal discipline in PPP implementations. A rigorous VfM (Value for Money) test, introduced as a due-diligence measure, now had to be met before a project was designated as a PPP. Korea’s experience with PPPs demonstrates the importance of balancing market promotion and fiscal discipline in PPP policy. A PPP system is sustainable when projects are (a) financially viable and bankable and (b) efficient enough to deliver VfM in fiscal management.