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Investment and Infrastructure

India Economic Forum


Background

The Union Budget 2021-22 lays strong emphasis on capital expenditure and infrastructure creation. Capital expenditure is proposed to be increased by 34.5 per cent to Rs 5.54 lakh cr in the financial year 2021-22 from Rs 4.12 lakh cr in 2020-21. Apart from this, Rs 2 lakh cr will be provided to states and autonomous bodies for their capital expenditure during the year beginning 1 April 2021. The Finance Minister has proposed this massive increase in capital expenditure despite the resource crunch as the government’s revenues have been badly hit due to slump in the economy. Further, there is a proposal to create an infrastructure-focused special financial institution called Development Finance Institution with a capital base of Rs 20,000 cr. It will be used for funding infrastructure projects which require long-term patient capital. The Finance Minister seems to have relied on the Keynesian theory of capital creation to spur growth and jobs. The higher investments in infrastructure should have a multiplier effect on the economy. Will the private investors pitch in taking cue from the increased public spending? Will it help revitalise the economy?

The panel on infrastructure comprised former planning commission member Arun Maira, BJP National Spokesperson for Economic Affairs Gopal Krishna Aggarwal, Power Finance Corporation CMD Ravinder Kumar Dhillon, Assistant Professor Rajeswari Sengupta (IGIDR) and Distinguished Fellow at NCAER and former Managing Director General at the Asian Development Bank, Rajat M Nag. The following set of recommendations are drawn from the discussion.


Recommendations

Largescale infrastructure investment is required, both to create efficient, low-cost logistics and drive growth in the current context. It requires sound projects, lots of capital, sound structures for mediating capital, good execution that also ensures timely release of funds, efficient mechanisms for the infrastructure that is built to pay for itself, functional structures of contract enforcement and, if things go bad, resolution of insolvency.


What to build

We need more of what is conventionally understood by infrastructure: roads, ports, airports, power generation plants, power transmission grids, distribution infrastructure, telecom tower and equipment, including optical fiber networks, perhaps satellite connectivity for inexpensive access in remote areas where fiber cannot be laid, pipeline networks for gas and oil, rail transport for goods and people, storage silos for grain, warehouses, climate controlled warehouses, refrigerated transport infrastructure. We also need a functional healthcare system and a functional safety net, given that the political economy will not allow things to work unless those who are dislocated by transient friction in the system are cared for. We will, perhaps, need unconventional infrastructure: new, ultra large battery storage for intermittently generated power or new kinds of storage such as molten sodium, whose latent heat can be released to generate steam that drives a turbine; or new, ultra-high voltage direct current transmission lines across time zones to make solar power available at times when there is no longer any local sunshine.


Before building

Project reports must be detailed and thorough. Environmental clearance should be realistic. The social buy-in is vital. For that there must be extensive consultation with people, to explain the costs and benefits and explicit provisioning, in costing the project, for compensating those affected by the project — physically displaced, communities disrupted or local livelihoods destroyed. That cost of compensation will have to be recovered through pricing of the infrastructure service. The public discourse must be primed to accept this.


Access to institutional credit/crop insurance

The government could directly execute the projects, as in the case of the National Highway Authority of India (NHAI) or the Railways. Or it could be done entirely by the private sector, shouldering the market risk, accepting regulation and pricing the infrastructure service in competition with other providers, as in the case of telecom. Or it could be done by the private sector in partnership with the government, as with renovating the airports in Mumbai and Delhi, the classic PPP model. 

The advantage of the government taking on and executing projects is that it would internalise many risks, which arise from parts of the government itself. Since the government would be able to mitigate these risks better than anyone else, the risk premium in the financing of the project would be low and the cost of the project would be far more efficient than if the project were taken up in the private sector. Once the project has got underway and all the developmental risks have been mitigated, it could be sold to private investors and the resources so realised recycled to fresh projects.

Private infrastructure projects face immense regulatory risk. Lack of clarity on the initial licensing terms, for example, what constitutes shareable revenue for telecom, can have devastating effects, dragging the private party and the government through decades of litigation. The regulatory assets created by the Delhi Electricity Regulatory Commission on the books of the private power utilities distributing power in Delhi, without any subsequent move to raise tariffs to pay them off, is a good example of suboptimal regulation vitiating business viability.

Contrary to the general impression that many people carry, the majority of PPP projects undertaken in the first decade of the 21st Century were completed and function well, including the airports of Delhi and Mumbai. Projects that ended up as bad loans on the books of banks include large capacity addition to power generation. Apart from a generalised tendency for Indian promoters to inflate project costs, there were signal problems arising from government conduct that derailed these projects. In some cases, governments backed out from their power purchase agreements. In others, the political culture of patronising power theft continued even when power distribution shifted to private utilities. 

This highlights the need for a shift in political culture towards respect for the realities of financing infrastructure. People do not fail to pay their telecom dues, because they know they will stop receiving the service if they do not pay. But when the infrastructure service is provided by the government, there is no such clarity. It must be brought about.

The grid failure in Texas, in the wake of a sudden plunge in the temperature to below freezing, showed another kind of regulatory failure. Texas has competitive power distribution, but inadequate investment in safeguarding the infrastructure against extreme weather events. Transferring the risk of such an event through insurance is one option but regulatory intervention to mandate precautionary investments would have forestalled a grid breakdown. For private markets to function efficiently in infrastructure, regulation has to be effective, efficient and comprehensive. There has to be sufficient investment in regulatory capacity as well, in other words.


How to finance?

Global savings are available in large pools looking for profitable deployment. The point is to give them comfort that their capital would be safe and adequately and assuredly serviced. That calls for good project preparation, project execution, monitoring, sound governance, globally comparable accounting and reporting standards.

A market for long-term corporate bonds is the basic requirement for infrastructure financing, whether routed through a development financing institution or not. Assurance about predictable dispute resolution, enforcement of contract and resolution of insolvency are part and parcel of investor comfort.


Recommendations:

  • Largescale infrastructure investment is required, both to create efficient, low-cost logistics and drive growth in the current context.
  • We also need a functional healthcare system and a functional safety net.
  • Project reports must be detailed and thorough and environmental clearance should be realistic. 
  • The social buy-in is vital and for that there must be extensive consultation with people, to explain the costs and benefits and explicit provisioning.
  • The government could directly execute the projects. The advantage of the government taking on and executing projects is that it would internalise many risks, which arise from parts of the government itself. 
  • Once the project has got underway and all the developmental risks have been mitigated, it could be sold to private investors and the resources so realised recycled to fresh projects.
  • There is need for a shift in political culture towards respect for the realities of financing infrastructure. People do not fail to pay their telecom dues, because they know they will stop receiving the service if they do not pay. But when the infrastructure service is provided by the government, there is no such clarity. 
  • For private markets to function efficiently in infrastructure, regulation has to be effective, efficient and comprehensive. There has to be sufficient investment in regulatory capacity as well. 
  • A market for long-term corporate bonds is the basic requirement for infrastructure financing, whether routed through a development financing institution or not.
  • Assurance about predictable dispute resolution, enforcement of contract and resolution of insolvency should be part and parcel of investor comfort.
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T K Arun

Consulting Editor, Economic Times
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