Role of Purchasing Power Parity in Public Private Partnership Projects (PPP Vs PPP)

?Purchase Power Parity:

The concept of Purchasing Power Parity (PPP) was introduced by the Swedish economist Gustav Cassel in the early 20th century, specifically in his work during the 1920s, theory that compares different countries' currencies through a "basket of goods" approach. The theory provides a like to like basis for comparison of living standards between two countries

However, much of the data and the practical implementation was possible when this emerged as an initiative in 1968 known as International Comparison Program (ICP) driven by World Bank to collect and analyse data on the purchasing power parity (PPP) of various countries.

What can cause this Purchasing Power Parity Gap among Nations?

- Price Level Variations: The cost of goods and services can vary significantly due to local market conditions, taxation, and supply-demand dynamics.

- Currency Exchange Rates: Fluctuations in nominal exchange rates can affect the relative purchasing power of currencies, leading to discrepancies in PPP.

- Consumption Patterns: Different countries have varying consumption habits and preferences, affecting the types of goods and services purchased, which can skew PPP calculations.

- Quality Differences: Variations in product quality, availability, and brand perception can lead to differences in prices that aren't accounted for in simple price comparisons.

- Market Structure: Monopolistic or oligopolistic market structures in some countries can lead to higher prices compared to more competitive markets.

- Transportation Costs: Costs associated with moving goods can differ based on geography and infrastructure, impacting local prices.

- Labour Costs: Differences in wages and productivity can influence the cost of services and goods, affecting overall price levels.

- Economic Policies: Government interventions, such as tariffs, subsidies, and regulations, can distort prices and influence the relative cost of living.

- Inflation Rates: Different inflation rates can lead to divergent price levels over time, impacting PPP calculations.

- Cultural Factors: Local customs and traditions can influence what goods are available and their prices, contributing to PPP differences.

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Nominal Vs PPP Adjusted GDP values:

Nominal GDP per capita (per person) can be considered a widely used economic indicator in the world. The amount of impact this data indicator has on a country is enormous. The Multilateral Agencies, Investors, Governments & Individuals would be making hundreds of critical decisions every day based on this very primary indicator. Yet have we ever thought of the importance of the impact of Purchasing Power Parity on GDP values? How much of a GDP value is hidden?

A solid example of the wide variance between Nominal GDP vs PPP Adjusted GDP is Sri Lanka.

The South Asian Nation has a Nominal GDP value of USD 3,828 (2023). As per the international categorization of world bank on income levels Sri Lanka belongs to lower middle-income threshold.

However, as per the GDP per capita adjusted for PPP – Purchasing Power Parity, Sri Lanka stands at the edge of a High-Income level country with USD 14,455 (2023). Sri Lanka also stands with unique club of countries with significantly higher gaps between Nominal Vs. PPP per capita. Table below provides a snapshot of few countries with such higher variance.

As per the above the income categorization levels of Bangladesh, Nigeria, Pakistan, India & Egypt must be uplifted, if their PPP adjusted GDP to be considered. Notably the Chinese GDP has to be uplifted by 85% of its current nominal levels.

One common factor among these countries with higher variance between the two bases is that relatively low minimum wage levels. Which may significantly impact the cost of the goods and services produced in an economy.

The choice between using Nominal GDP and Purchasing Power Parity (PPP)-adjusted GDP values can significantly influence the structure, execution, and outcomes of Public-Private Partnership (PPP) projects in India. Here’s a detailed exploration of their roles:

Nominal GDP in PPP Projects -

Nominal GDP represents the economic output of a country measured in current market prices without adjusting for cost-of-living differences or inflation.

Advantages

1. Global Benchmarking: Nominal GDP is widely used for international comparisons of a country’s economic strength, making it a useful metric for attracting foreign investments in PPP projects.
2. Debt Servicing Analysis: It provides insights into a country's ability to service external debt and fund large-scale infrastructure projects, which are key components of many PPPs.
3. Investment Risk Assessment: Foreign investors assess the nominal GDP to evaluate currency risk, inflation rates, and exchange rate stability before committing to long-term PPP projects.

Limitations

1. Disregard for Real Economic Power: Nominal GDP does not reflect the population's actual purchasing power, making it less effective for setting tariffs or pricing strategies in user-driven PPP models.
2. Regional Inequalities: It overlooks cost-of-living variations within India, where disparities across states can influence project viability.

PPP-Adjusted GDP in PPP Projects -

PPP-adjusted GDP accounts for the relative cost of living and inflation differences between countries, providing a more accurate measure of real economic power.

Advantages

1. Affordability and Pricing: PPP-adjusted values help design pricing strategies (e.g., tolls, electricity tariffs) that align with the population’s purchasing power, ensuring affordability and service uptake.
2. Demand Forecasting: It is a better metric for predicting user demand for services in sectors like transportation, water supply, and healthcare, where affordability directly affects participation.
3. Attracting FDI: By reflecting India’s high purchasing power in global terms, PPP-adjusted GDP makes PPP projects more appealing to foreign investors, particularly in infrastructure and utilities.
4. Balanced Regional Development: PPP-adjusted metrics can help tailor projects to the real economic capacity of specific regions, reducing imbalances and fostering inclusive growth.

Limitations

1. Limited Currency Risk Insights: Unlike nominal GDP, PPP-adjusted GDP does not reflect market-based currency fluctuations, which are critical for cross-border investments.
2. Complexity in Financial Modelling: Using PPP adjustments requires more sophisticated analysis and may introduce inconsistencies if not uniformly applied.

Implications for India’s PPP Projects

1. Infrastructure Tariffs: PPP-adjusted GDP is crucial for pricing models in sectors like transportation and utilities, ensuring that services remain accessible to lower-income groups while maintaining financial viability.
2. Investment Dynamics: Nominal GDP highlights India’s large economy, attracting foreign investors. However, PPP-adjusted GDP underscores its cost-efficiency and high consumer base, providing a complementary perspective.
3. Balanced Negotiations: Using both metrics allows governments and private partners to balance global investor expectations with local economic realities.

?Nominal GDP serves as a global benchmark for assessing India’s macroeconomic strength and investment risk, while PPP-adjusted GDP provides a nuanced understanding of real economic capacity, crucial for structuring viable and inclusive PPP projects. Leveraging both metrics ensures comprehensive planning, better pricing strategies, and equitable growth in India's infrastructure development.

Purchasing Power Parity (PPP) significantly influences the economics and viability of Public-Private Partnership (PPP) projects in India by impacting cost estimation, revenue projections, investment attractiveness, and risk management.

Some of the key PPP projects for learnings: Bujagali Hydropower Project-Uganda, Delhi:Gurgaon Expressway-India, Indiana Tol Road-USA

Here’s how it shapes these aspects:

1. Cost Estimation and Financial Modelling

• Real Cost Adjustments: In PPP projects, particularly infrastructure development like highways, metro systems, and utilities, using PPP ensures costs are benchmarked to the real purchasing power of the population rather than nominal currency values. This is crucial in a diverse economy like India, where regional disparities in income levels can impact project affordability and feasibility.
• International Investments: For foreign investors, PPP-based adjustments provide a realistic view of costs and returns in local economic terms, making Indian projects more transparent and comparable to global standards.

2. Revenue and Demand Projections

• Affordability and User Fees: PPP helps structure user fees for services like tolls, water supply, or electricity, ensuring that pricing aligns with the population's economic capacity. This balance fosters public acceptance and long-term sustainability.
• Demand Forecasting: By aligning projections with PPP, policymakers can better estimate service demand, as it considers the real income and spending capacity of users, reducing over- or underestimations.

3. Investment Attractiveness

• Foreign Direct Investment (FDI): India’s PPP-based cost advantages make it a preferred destination for global investors. Foreign entities assess project returns through PPP adjustments, ensuring competitive advantages in terms of resource costs and returns.
• Risk Mitigation: For long-term projects, PPP calculations help hedge against inflation and currency depreciation by focusing on real economic value rather than nominal fluctuations.

4. Inclusive Development

• Equitable Access: Infrastructure projects designed using PPP are more likely to include pricing models that accommodate lower-income populations, promoting inclusivity while ensuring projects remain financially viable.
• Public Utility Enhancements: For essential services like healthcare, sanitation, and rural connectivity, PPP ensures affordability while maintaining service quality.

5. Risk Management

• Economic Stability: PPP helps structure agreements that withstand macroeconomic changes, such as inflation or currency depreciation, by linking revenues, ?costs, and financial obligations with PPP, projects can remain financially viable despite changes in currency value or inflation to real purchasing power.
• Revenue-Sharing Models: Governments and private players can create fair and sustainable revenue-sharing mechanisms, reducing the risk of disputes.

• Inclusive Development: PPP-based adjustments ensure that infrastructure projects remain accessible to lower-income groups, promoting equitable development.

Conclusion

The use of purchasing power parity in PPP project planning ensures that costs, revenues, and investments reflect real economic conditions rather than nominal values. This promotes financial accuracy, risk reduction, and investment attractiveness, making PPP an essential tool in executing large-scale, sustainable public-private partnership projects.

In India, where economic disparities and inflationary pressures are prevalent, Purchasing Power Parity (PPP) serves as a critical tool for structuring Public-Private Partnership (PPP) projects. By aligning costs, revenues, and investments with the real economic conditions of the population, it ensures sustainability, inclusivity, and long-term financial viability, driving infrastructure growth while supporting equitable development.