The Hindu Business Line : Infrastructure: The core inadequacies

There is infrastructure shortage because private investors are not sure if the risks they take will be matched by returns from the project; the government is not able to create projects that can be taken to investors; and the inadequate regulatory reform. The aim of the government and of regulators should be to encourage competition as best as possible in every segment of infrastructure.

Infrastructure services are seen as a basic right of citizens and the government is expected to provide them free or at minimal charge. Though governments have struggled to improve the quality of infrastructure, its inadequacy is a fundamental constraint to the country's growth.

Investors, and now even the lay people, understand that a modern factory will not be very productive without access to basic infrastructure. Growth and diversification of Indian agriculture into value-added activities such as food processing or packaged exports is impossible unless a network of cold storages, efficient transportation, reliable power systems and robust telecom networks is set up.

The required outlay for building infrastructure in India is very large. The consensus is that over the next five years (2007-12) India needs to invest about $350 billion in infrastructure projects including roads, ports, airports, railway lines, urban facilities, irrigation, and power. It is clear that the government cannot put in the money all by itself without fiscally stretching itself and violating the limits set under the Fiscal Responsibility and Budget Management Act. The Government accepts that the private sector has a significant role to play if the required infrastructure is to be built.

PUBLIC-PVT PARTNERSHIP

The answer lies in the now increasingly popular model Public Private Partnership. PPP has met with some success (and some notable failures) all over the world, and experience suggests that the concept needs to be implemented with skill and care.

The third `P' is the core of the concept. Each player is supposed to play the role he is best suited to. Also, if the partnership is poorly structured it is not likely to succeed. The key is allocating risks to the entities best positioned to assume them. Thus, the commercial risks are best borne by investors, who do it for a threshold return, and the non-commercial risks (political, environmental, regulatory and so on) by the government. Most infrastructure projects that fail do so because this principle gets violated.

While $350 billion sounds like a lot of money to be raised in a few years for provision of infrastructure, it can be argued that there is actually not so much a shortage of capital as there is a dearth of bankable projects.

Most investors are stumped by this paradox: When India is growing so furiously and the potential is so obvious, why are the real opportunities to invest so hard to find?

THREE OBSTACLES

There are three main reasons for the dearth of bankable projects:

Private investors are not sufficiently assured that the risks they take in investing are matched by returns from the project, and/or the lenders (public/private sector alike) may not be convinced that the credit risks are adequately covered.

There is insufficient capacity in government to create infrastructure projects that can be taken to investors and lenders.

An important contributory reason to the above two and one that merits a separate mention is the inadequate regulatory reform and/or lack of clarity in many sectors to attract private investment.

Users charges

For infrastructure projects to become a reality, there has to be a willingness in society (and the polity) to recognise that infrastructure costs money to set up, and that the service provider needs to be fairly compensated.

If service providers are prevented from charging a return that covers their costs, private investments will not come into that sector, unless there is a state subsidy.

Sometimes, there is political unwillingness to impose fair user charges (for example, power tariffs for the agriculture sector or water charges), which scares investors away. But governments, bound by their fiscal situations, need to sensitise consumers to pay a user charge.

Proper concession design

Many, including in the government, think that in investing in the infrastructure sector, the investor is essentially aiming to make money at the expense of the government.

Arising from this bias, or sometimes from a genuine zeal to protect public funds, there is a tendency to make PPP projects (essentially the concession design) so rigid that progress becomes hard.

Needed is clear government support for infrastructure project by way of sound project conception, scientific concession design, providing viability gap funding where necessary, creating effective regulation, and then allowing private investors to participate with clearly set rules.

While preventing monopoly profits in infrastructure is a legitimate goal of public policy, it should not lead to artificial limits on profits or restrict such returns based on mechanistic formulas or populist demands.

Otherwise, incentives for investment, innovation, efficiency, and productive growth — badly needed in the infrastructure sector — would be undermined or eliminated.

Quality of regulation

Effective and stable regulation is vital to ensuring that private capital flows into infrastructure. Among other issues, a core element of good regulation would be to strike an effective balance between consumer and investor protection.

Successful reform requires regulation that spells out consumer rights, clarifies property rights and allocates them sensibly, and assures private investors that their sunk investments will not be subject to regulatory whims or opportunism.

The track record of India in creating effective and stable regulation, despite some good initiatives, has been patchy in different sectors. The principal factors for this are (1) The government has not been successful in staffing the key positions of the regulatory body with knowledgeable professionals; and (2) The government has not given the elbow room to the regulatory body to balance the interests of all stakeholders.

ROLE OF REGULATORS

Some steps that Government will necessarily have to take in this regard are:

The Government should ensure that individual ministries do not undermine the independence of regulators in their respective areas. While this is easier said than done, it is vital for the Government to get the ministries to part with power to the regulator if independence is to be created.

The Government should desist from making regulatory bodies the preserve of retired bureaucrats and judges.

The Government must ensure regulatory boards/commissions also have top-notch professionals from industry and academia area.

Regulation should seek to increase competition or play of market forces

This may sound a bit contradictory in the bid to attract private investments into infrastructure, but it needs to be done. The aim of the government (in project design and award of concession) and of regulators should be to encourage competition as best as possible in every segment of infrastructure.

Capacity building

For all of the above to happen, there is an urgent need to substantially enhance the knowledge and skillsets of government, bureaucrats, senior bankers, the judiciary, and regulators, on the intricacies of infrastructure development and finance.

A doyen of Indian economics, Dr. V. K. R. V. Rao, noted more than 25 years ago that, "The link between infrastructure and economic development is not a once and for all affair. It is a continuous process; and progress in development has to be preceded, accompanied, and followed by progress in infrastructure, if we are to fulfil our declared objectives of generating a self-accelerating process of economic development."

(The author, associated with the Madras Chamber of Commerce and Industry, is Managing Director, ImaCS)

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