Private Finance Initiative (PFI) Seminar Key Note Address by YB Tan Sri Nor Mohamed Yakcop

Private Finance Initiative (PFI) Seminar
Key Note Address

By:

YB Tan Sri Nor Mohamed Yakcop
Minister of Finance II
10 November 2006
Impiana Hotel, Kuala Lumpur



YBhg. Dato Shahrir Abdul Jalil,
Managing Partner of Shahrizat Rashid & Lee,

Mr. Alan Jenkins,
Chairman of Eversheds,

H.E. Mr. Boyd McCleary,
British High Commissioner to Malaysia

Distinguished Guests,

Ladies and Gentlemen,

Assalamualaikum w.b.t and Good Morning,

I would like to express my appreciation to the organisers for inviting me to speak at today's seminar on Private Finance Initiatives (PFI). This seminar is indeed timely and I would like to commend both Eversheds and Shahrizat Rashid & Lee for taking this initiative, a private initiative to advance the discussions on implementing PFI in Malaysia.

2. YAB Dato' Seri Abdullah bin Hj. Ahmad Badawi, Prime Minister of Malaysia, first mentioned Private Finance Initiatives (PFI) in his speech at the tabling of the Ninth Malaysia Plan, as a key modality to implement the country's national development agenda going forward. The 15 year National Mission articulated by the Prime Minister is a major challenge for the country, in striving to achieve the vision of developed nation status by 2020. We therefore require the full commitment and effort of both the public and private sectors to achieve Vision 2020. The introduction of the PFI concept by the Prime Minister is a key part of this effort as it involves establishing an optimal relationship in the partnership between the public and the private sector in driving national development.

3. Using PFI in pursuing national development must be seen in the context of the Government's broader policy priorities of energising the private sector as the engine of national economic growth and, at the same time, improving public delivery and services. Strong and sustained growth is required to maintain the trajectory towards Vision 2020. In order to achieve this, the success of the Ninth Malaysia Plan rests heavily on maintaining double digit growth rates for private investment. Towards promoting private sector consumption and investment, the Government has consistently maintained pro-growth economic policies.

4. The 2007 Budget clearly demonstrated the Government's focus on stimulating private sector participation. Firstly, the Budget was expansionary both in terms of expenditure and taxation. Secondly, comprehensive incentives were outlined for private sector participation in new growth sectors, particularly Biotechnology and Islamic Finance. Thirdly, the Government announced initiatives for joint investment between the Government and the private sector to catalyse new investments areas, such as in Southern Johor. Fourthly, the Prime Minister also articulated in the Budget the principles of disclosure, transparency, accountability and mutual trust as principles to enhance public delivery through private sector participation. Overall, the 2007 Budget very much reflects the Government's philosophy of increasingly facilitating a conducive environment for doing business, whether through providing infrastructure, enhancing public delivery or enhancing the tax system and where necessary to promote strategic sectors, providing the private sector with assistance, whether in the form of incentives or joint investment.

Ladies and Gentlemen,
5. The introduction of PFI provides the Government with options going beyond the existing modalities of implementation, which thus far has mainly focused on either privatisation or conventional Government funded projects. In fact, in the Malaysian context, we view PFI in the broadest of terms, as capturing a wide spectrum of options that lie between the two extremes of privatisations and Government projects. In its purest forms, privatisation involves the private sector financing the project entirely and taking all the risks, including revenue and viability risk. Government projects lie on the opposite end of the spectrum, whereby the projects are funded by the Government and the private sector is limited to typically just execution or construction risk. Even then, for Government funded projects, ultimately the Government is still exposed to the risk of having paid progress payments but with the contractor unable to complete the project. PFI, as a broad concept, recognizes the scope for a mutually beneficial arrangement in terms of the different permutations of structuring the relationship between the Government and private sector, particularly in terms of the allocation of risks and financing. The scope for formulating a win-win scenario arises because different projects involve different risks and rewards, and between the private sector and the public sector, certain risks and rewards are best borne by one party compared to the other.

6. In the Malaysian development context, among the key areas identified as suitable for the implementation of PFI include regional development such as for the Southern Johor Economic Region, education, public transportation, health and water infrastructure. As elaborated by the Prime Minister, in the Ninth Malaysia Plan, the PFI approach will be utilized broadly in two circumstances - first, to optimize implementation of Government projects and services; and second, to enhance the viability of private sector projects in strategic or promoted areas.

7. In the first circumstance, optimization in the implementation of Government projects includes both in terms of value for money and also in terms of the quality of public services. Take for example, the construction of a Government building. Undertaken as a conventional construction project, the Government is exposed, in the short run, to completion risk and, in the longer run, to the risk of escalating maintenance costs, especially where the contractor has no interest in ensuring the long term durability of the building. Alternatively the project could be undertaken using a Build, Lease and Transfer approach, whereby the private sector will lease the building to Government say for 20 years at a fixed lease including maintenance. In this structure, the Government does not start paying until the building is satisfactorily completed and ready for use. In the longer run, there is no risk of escalating maintenance costs. Indeed with this structure, the private sector is incentivised to ensure a higher quality of construction to avoid the future burden of high maintenance costs. This simple example demonstrates the scope for value for money by avoiding the risk of maintenance costs and better quality in terms of the building construction.

8. Maintenance is indeed a good example where private sector is well positioned to be more efficient and better able to manage the risk of controlling costs. This applies not only in terms of buildings but also in terms of equipment and transportation facilities such as trains and buses. A key factor in securing the potential benefits of the PFI approach is structuring the arrangement to ensure that the right risks are borne by the right party and that the incentives of the private sector are aligned appropriately. Key performance indicators or service level agreements can be put in place with the appropriate financial carrot and stick to derive the optimal relationship. It is in this context that advisors, both financial and legal, many of whom are present today can help create value, drawing from international experience, to advise the Government and private sector participants in terms of how best to achieve an efficient and equitable sharing of risks and rewards.

9. The Government has already commenced implementation of this type of PFI projects. The projects have been identified and work has started in terms of preparation of designs and award of contracts. Pembinaan BLT Sdn Bhd was formed last year and by the end of this year would have commenced implementation on more than RM 2 billion worth of projects relating to police quarters and buildings, using a Build Lease and Transfer approach. Under the Ninth Malaysia Plan, an amount of RM20 billion worth of projects, including schools and Government buildings, was also approved to be implemented using the Build Lease Transfer approach. In the international experience, the efficiency savings from private sector bearing the risks have often been partially offset by the higher cost of financing by the private sector. In the model implemented by Government under for example Pembinaan BLT, not all of the risks have been transferred to the private sector. However, the financing has been secured based on the lower Government cost of funding. Going forward, we expect to engage with the private sector on different permutations of risk and reward sharing towards continually improving our PFI structures.

Ladies and Gentlemen,
10. In the second circumstance identified by the Prime Minister, the Government will help enhance the viability of private sector or privatisation projects in strategic or promoted areas. The basic rationale here is that there are various potential private projects which could be on the borderline in terms of viability and may therefore not be implemented. However, amongst these projects, there would be some which are highly beneficial to the country, in the sense that it would result in significant benefits and spinoffs, which are public good in nature and not be fully captured by the private sector party. With a little assistance from the Government, these projects can be implemented with the private sector bearing all the risk and accruing the private returns, and at the same time the country benefits. Again, this would be a win-win arrangement between the Government and private sector.

11. The Prime Minister has already announced a facilitation fund of RM 5 billion to provide such support. Thus far, the Government has already announced that the 2nd Penang Bridge will proceed on this basis. The principle is well demonstrated here in the sense that whilst a privatized concession alone may not be sufficient to finance the project, the project will result in large spinoffs for the development of the Northern region and thus justifies Government support. To evaluate projects such as these, a central PFI unit has been formed, with its secretariat based in the Economic Planning Unit.

12. This approach of enhancing viability of private sector projects will also be utilized where Government assistance can play a role in catalysing and create a momentum of investment in new growth areas. As mentioned earlier, such measures were announced in the 2007 Budget.

13. One such measure was the formation of the Creative Industry Development Fund with an initial allocation of RM 100 million. The Fund will be used to jointly invest with private sector parties in developing export quality media content. Amongst private sector parties identified to participate include Media Prima and TM. We have seen the success of the Indian and Korean film industries. We believe Malaysia is not short of talent. Thus, the Government believes a focus towards producing high quality content, whether in the areas of film, animation, computer games or theatre has the potential to develop into a thriving industry. Whereas in the past the Government promoted new growth industries primarily through tax incentives, a PFI approach is now available as another modality to build up a strategic infant industry.

Ladies and Gentlemen,
14. In addition to new industries, the PFI approach will be utilized to develop new regions. In the 2007 Budget, in addition to the amounts to be spent on infrastructure, a specific allocation of RM 200 million was provided to establish a strategic investment fund for the Southern Johor Economic Region. The fund will be utilized to spur investments in new industry clusters, particularly for private sector education and healthcare. Towards catalyzing a more rapid development of these clusters, the fund will be used as an incentive to support and jointly invest with the early entrants.

15. In addition to providing support through joint investments with private sector parties, we expect there are many innovative means to help private sector parties to enhance viability in a mutually beneficial manner. To assist the initial entrants of private universities and hospitals into Southern Johore, the Government could enhance viability by committing to procure a level of services in the future, such as sending a certain number of Government sponsored students to these universities. The commitment however would be tied to performance criteria such as quality of education and employability of graduates. This can operate as an incentive for the university to improve itself towards securing more Government sponsored students.

Ladies and Gentlemen,
16. The success of the PFI rests on getting an optimal partnership between public and private sector in terms of sharing the risks and rewards, in addition to incentivising the alignment of interests. Well structured, a PFI approach will be mutually beneficial in providing the private sector a market return and providing the Government with value for money, higher quality of public services and broader economic spinoffs. I am confident that the PFI approach will increasingly play a larger role in promoting strategic private sector investments. The Government looks forward to engaging with the private sector in developing workable and efficient PFI models towards advancing the national development agenda.

17. It is through seminars such as these that both public and private sector participants are able to gain insights from international experience in order to develop applications for Malaysia. I would like to again thank the organizers and sponsors making today's seminar possible, and wish all of the participants today a fruitful discussion.

Thank you.


10 November 2006