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July 4, 2010

In search of the wrong saviours

Frequent trips abroad by Minister of Road Transport and Highways to solicit investors, and the recent pronouncement regarding $1 trillion requirement for funding infrastructure in the twelfth plan period (2012-17) have centred the debate on huge funding deficit facing infrastructure development. The constant refrain ascribes slow pace of infrastructure development to unavailability of foreign capital.

While our overall financial architecture might lack suitable financing mechanisms, it is the consequences of prevailing political economy of infrastructure development, rather than a lack of capital, that hinder private sector from participating effectively in infrastructure development.

Over the last decade or so, the dominant model of infrastructure development in India has consensually evolved into the public-private partnership (PPP) model to leverage the limited public resources for large scale development. Apart from budgetary constraints, the rationale behind the various forms of PPP arrangements is to bring in efficiencies and innovative management practices in public projects by partnering with the private sector—reducing project cost and thereby providing a better value for money to the user of services.

Despite fiscal incentives like tax holidays and permitting 100 percent FDI in select sub-sectors, foreign capital still eludes us. Financing infrastructure projects is inherently risky due to non-recourse or limited recourse liability, long gestation periods and unstable cash flows spread over decades. Besides, the risks perceived by the private sector, even when in partnership with the government: policy risk, regulatory risk, political risk and exchange rate risk, to name a few.

Agglomeration of these risks due to adverse selection problem steeply raises the risk profile of a project, particularly in the foreign investors’ perception, and thus necessitates higher returns. This prohibitively high cost of capital of funding a Special Purpose Vehicle (SPV) often renders the bid uncompetitive. Moreover, a foreign investor might feel that the size of the Indian projects is smaller in comparison to the global average, and, given the available choice could forsake India due to the comparatively skewed risk-return ratio.

Therefore, it will be improvident on our part to wait for foreign capital to fulfil our infrastructure lending requirement. Instead, it is important to create appropriate financing mechanisms to channelise India’s savings rate of around 32 percent—amounting to approximately $450 billion—into infrastructure. This will involve, at a minimum, developing an active bond market, allowing insurance companies and pension funds to invest in wider asset classes, and according a greater role to specialised Non Banking Finance Companies (NBFCs) in lending to infrastructure SPVs and consortia.

Concurrently, for financing large infrastructure projects, Indian government should utilise soft loans of longer duration like those from the Japan’s Official Development Assistance (ODA) for Delhi Metro and western leg of the Dedicated Freight Corridor (DFC) project, among others. Today India is the largest recipient of ODA loans, but such collaboration has been an outcome of the convergence of New Delhi’s and Tokyo’s geo-strategic interests, by sustained diplomatic engagement at the highest political level, beyond the interests of Japanese businesses in India.

It is not finance but managing the other issues arising out of the political economy of infrastructure which will determine the pace and direction of infrastructure development. To start with, the ideological opposition by a section of the political class and civil society to private participation in infrastructure development still exists. Infrastructure services are seen as a pure public good to be provided free of cost by the state. It blindly equates private participation as profiteering at the expense of common man and derives political mileage without laying down any alternatives to user fee based approach of PPPs or earlier tax based funding approach.

To add to this, cases like the Delhi-Noida toll bridge—a build-own-operate-transfer project—where the concessions do not serve the public interest, and the bidding process for the modernisation of the major airports only serve to strengthen the perception of rent-seeking and a sell-out to business. Setting up of separate or unified, independent regulatory and adjudicatory bodies for various sectors, as in telecom, to monitor performance and user charges agreements are already a long overdue step.

Despite availability of finance and a PPP agreement in place, land acquisition is the biggest factor which continues to delay most projects. Acquiring land—through eminent domain powers–must not be seen from a purely legal perspective but from a broad socio-economic perspective. Unless prompt market based compensation is paid to the correct owners, acquiring land will remain a tortuous process and delay the infrastructure projects.

At present, the majority of PPP projects are the ones undertaken by the Union government. Co-ordination with the state governments often creates hurdles—more out of sheer political animosity than out of a difference of opinion—and is another source of delays. The recent withdrawal of the Uttar Pradesh government from the Umbrella State Support Agreement (Umbrella SSA) to be signed with the Ministry of Road Transport and Highways is a case in point.

Delivery of quality infrastructure services at affordable charges in sectors with high visibility, for instance highways, is extremely important at this stage to build continued public support for and acceptance of PPP model. This will automatically help in transition of the PPP model to other sectors like water supply, sanitation, waste management, warehousing, including social sectors—health care and education—at a much larger scale. Once the PPP model gains widespread acceptability and when sufficient expertise and experience is available with the Union and state governments to enter into PPP, innovative arrangements can be tried by the lower government bodies—municipalities and village panchayats—by drawing on the cumulative experience.

The complex interplay of various dimensions of the political economy increases overall business risk; therefore, deft management of these will not only reduce the risk perception and automatically lead to capital flows but ensure real progress on ground. Careful stewardship by the government with a political will is crucial to the success of this model; otherwise, sustained rapid economic growth over the next few decades will remain a pipe dream due to substandard infrastructure.


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