INFRASTRUCTURE

The Problems

1. India needs more and better infrastructure – power plants, highways and urban amenities – if it is to grow faster. But not enough money is being invested in building infrastructure.

2. Some of the money that is needed can come from taxes and other forms of government revenue. But most of it will have to come from the private sector. Unfortunately, the private sector is now unenthusiastic about investing in something as risky as infrastructure. Banks are also unwilling to lend.

3. Earlier attempts to involve the private sector, such as through PPPs, have run into trouble – sometimes the private partner asked for better terms, at other times the government was slow with approvals, and projects stalled.

4. The government will have to balance the need to build infrastructure, the limited amount of money it has and the difficulty of working with the private sector. How can it do that?

Slow Pace of Infrastructure Buildout: Concerns and Key Steps^*

Pranjul Bhandari

India’s large investment deficit is well known. The investment rate has fallen by about six percentage points since the highs of 2011–12. The Asian Development Bank estimates that over the next five years the gap between current and needed investment levels will be about 4 per cent of GDP ($112 billion) annually.¹ It further estimates that public finance reforms could generate additional revenues to bridge up to about 40 per cent of the gap. Money to bridge the 60 per cent or so that remains will have to come from the private sector.

In addition to increasing spending on infrastructure while maintaining macroeconomic stability – in other words, while keeping an eye on the deficit and inflation – the government can help incentivize private investment by speeding up the resolution of stalled projects and partnering with private investors (via PPPs).

Maintain macroeconomic stability

Keeping the macro house in order is the primary requirement for creating an environment that scales up investment.

· Fiscal consolidation is necessary to keep borrowing costs for private investors low and to ensure that the country has a healthy stock of savings to channelize into investments.²

· Low inflation ensures stable returns to investors – they have a clearer idea of what they are getting in return for their investment.

· We have found that policy uncertainty is a huge dampener for investment. Well-articulated policy decisions that bring in certainty and minimize surprises are necessary for private sector capital expenditure to grow and flourish.

Reform public finance

The government needs to scale up infrastructure spending, but in a fiscally responsible way, so that it remains sustainable. We recommend the following:

· Switching government expenditure from current expenditure, on such things as wages and salaries (running at 11.4 per cent of GDP presently), to capital (1.6 per cent of GDP), without abandoning the fiscal glide path. Targeting subsidies at those who really need them and weeding out sub-scale legacy expenditure schemes can lower the current expenditure bill.

· Raising revenues by removing the many exemptions and distortions in the current GST structure.

· Swapping assets, i.e., selling additional spectrum, disinvestment from the public sector and monetizing government landholdings, and using the proceeds to invest in new infrastructure projects. Recycling capital by selling/auctioning brownfield assets and allocating proceeds to finance greenfield infrastructure.³

· Other innovations include land value capture, a method by which the increase in property or land value due to public infrastructure improvements is captured through land-related taxes or other means to pay for the improvements.⁴

· Setting user charges for infrastructure services with greater regard to cost recovery will also help.

Untangle stalled projects

India’s stock of stalled projects rose sharply from 2011 onward.⁵ While they have moderated a notch from the highs, the ‘stalling rate’ for private capex projects remains elevated (at 24 per cent versus the long-term average of 13 per cent). Freeing up these projects is an important driver of new private sector capital expenditure.

One-third of the stalled projects are due to government policies.⁶ We provide recommendations to address three main reasons of policy-related stalling:

· Land acquisition: Since the enactment of the 2013 Land Acquisition, Rehabilitation and Resettlement (LARR) Act, some states have explored innovative models of procuring land for infrastructure projects that don’t invoke the LARR. Andhra Pradesh, for example, has pioneered the ‘land pooling’ model for the greenfield state capital Amaravati, where 25,000 farmers have voluntarily pooled 33,000 acres of land. By giving them an alternative form of compensation, in this case a share of the developed land, among other benefits, the state has made them direct stakeholders in the success of the project. We recommend that such incentive-compatible models are codified and encouraged.⁷

· Environmental clearance: The incoming government should consider strengthening the institutional architecture for environmental regulation to ensure greater transparency and to enable decisions to be driven directly by the data. We recommend the establishment of an independent, professional environmental regulator, with adequate teeth and specialist expertise to appraise projects and monitor compliance.⁸

· Raw material availability: Lack of direct access to coal from mines – coal linkages – continues to be the biggest reason for policy-related stalling. Operationalization of the new Coal Mining Policy (which includes commercial miners) needs to be expedited.

Revitalize public–private partnerships

There is broad consensus that getting PPP models right is critical, and the lived experience of PPPs over the last two decades provides valuable lessons.

· Operationalize an apex national-level entity for institutional capacity building, research and analysis on PPPs in India (‘a public–private partnership institute, or 3PI’).⁹

· Establish sector regulators and ‘best practice’ design principles (governance, expertise, processes, etc.).

· Outline key principles for risk allocation in PPP contracts. Establish clear norms for financial oversight of special purpose vehicles (move to commercial audit from government audit, which is currently open for access under the Right to Information Act and Article 12 of the Constitution). Outline clear norms for renegotiation of agreements. Operationalize a robust but nimble dispute resolution mechanism.

Some sector-specific recommendations

· Railways: Embark on a step-wise freeing up of the railways. Establish an independent regulator which has the power to fix fares and goods tariff rates as well as fair access regulation, licensing and technical standards. Separate operations from the setting up of infrastructure.¹⁰

· Roads: Given the sheer number of roads and highways that need to be built or upgraded, different models need to coexist. The currently popular ones are toll–operate–transfer and the hybrid annuity model (HAM). A sector regulator (discussed under the PPPs section) will need to advise on the optimal mix of the different models.¹¹

· Power: India will continue to need more power, and that means stronger attempts to reform the state electricity boards (SEBs) than has been attempted so far.¹² Further, as renewables become a larger share of power generation, the transmission grid will need to be redesigned appropriately.¹³

· Urban infrastructure: Incentivizing state governments to give more freedom to municipal bodies may be necessary. The 14th Finance Commission earmarked additional funds for municipal bodies, and that can be scaled up further over time.

Develop the corporate bond market

While banks will remain an important finance vehicle for investment, increased capital requirements (like Basel III) and the inherent maturity mismatch related to long-term project lending implies bond financing must assume a greater role to complement banks.¹⁴

The Solutions

1. The government will have to make sure that the Indian economy looks attractive and stable – with low inflation, solid regulation and steady policies.

2. Some projects in the past ran into trouble because government clearances were slow or raw materials became unavailable. Ensure that does not happen again.

3. Don’t abandon PPPs. Instead, increase the capacity in the government sector to manage these partnerships, and give these new regulators independence, funding, expertise and power.

4. Find other ways for households’ savings to be channelled into infrastructure, besides banks. One way is to build up a market for corporate debt or bonds.

^*The author would like to thank Neelkanth Mishra for useful discussions and suggestions.

¹See https://www.adb.org/sites/default/files/publication/227496/special-report-infrastructure.pdf

²See Prachi Mishra’s note in this volume, ‘Responsible Growth: Way forward for India’, for a discussion on a sustainable path for public debt and the fiscal deficit.

³This is already happening in road projects, where the government is transferring completed roads to the private sector (the toll–operate–transfer model) and using the resources to build new roads (the engineering–procurement–construction model). Completed projects can be sold to domestic and foreign institutional investors who have long-term liabilities but a limited appetite for risk.

⁴A variant of this was tried in the Hyderabad Metro project. The government leased adjoining land for commercial activity to Larsen and Toubro (L&T) for sixty years.

⁵Based on data from the capex database maintained by the Centre for Monitoring Indian Economy (CMIE). Stalling rate is defined as projects stalled as a percentage of projects under implementation.

⁶The remaining are due to market conditions, etc. We find that the twin balance sheet problem, weak world growth, increased policy uncertainty and lower expected future returns explained a large proportion of the capex slowdown (see Pranjul Bhandari and Dhiraj Nim, ‘India’s Investment Challenges: What Can Go Right’, HSBC Global Research).

⁷For a detailed discussion, see Maitreesh Ghatak’s note in this volume, ‘Land Market Reforms’.

⁸A detailed blueprint for such an entity – a National Environmental Appraisal and Monitoring Authority (NEAMA) – was put together in 2011, and in 2015 the Supreme Court repeatedly asked the government to constitute such an authority.

⁹The Kelkar Committee strongly endorses the ‘3PI’ which can, in addition to functioning as a centre of excellence in PPPs, enable research, review, rollout activities to build capacity, and support more nuanced and sophisticated models of contracting and dispute redressal mechanisms. See ‘Report of the Committee on Revisiting & Revitalising the PPP Model of Infrastructure Development Chaired by Dr. V. Kelkar’, http://pib.nic.in/newsite/PrintRelease.aspx?relid=133954

¹⁰These recommendations are in line with the Bibek Debroy Committee report, ‘Report of the Committee for the Mobilization of Resources for Major Railway Projects and Restructuring of Railway Ministry and Railway Board’, http://www.indianrailways.gov.in/railwayboard/uploads/directorate/HLSRC/FINAL_FILE_Final.pdf.

¹¹In a surge of ordering in recent times, many companies with weak balance sheets have won orders. They may not achieve financial closure easily and, consequently, specific sections of roads projects could get stuck.

¹²For more, see Prachi Mishra’s note in this volume, ‘Responsible Growth: Way forward for India’.

¹³For more, see Neelkanth Mishra’s note ‘Energy Reforms’ in this volume.

¹⁴For a detailed discussion on steps needed to develop the corporate bond market, see Eswar Prasad’s note in this volume, ‘Financial Sector Developments and Reforms’.

3