The Hindu Business Line : Budget: Overcoming roadblocks to growth

India has a very large network of poor quality roads. The stretch of national highways that carries 45 per cent of total traffic is mostly two-lanes with heavy traffic, low service and slow speeds. Road maintenance is grossly under-funded, with only one-third of needs being met.

PERHAPS one of the most striking pronouncements by the Finance Minister, Mr P. Chidambaram, during his Budget speech was, to quote Mr Chidambaram, "At a recent meeting of G-7 finance ministers in London (that India and China attended) China's finance minister looked in my direction and said China had received $60 billion of foreign direct investment in 2004".

India's Foreign Direct Investment (FDI) last year was less than 10 per cent of China's. Ignoring for the time being the ongoing academic discussion on FDI composition anomalies, the comparison with China in the Budget speech is acknowledgement of the increasing international visibility of China's aggressive growth policies.

Building world-class infrastructure has been the key to the transformation of the Chinese economy from planned to market-oriented.

According to studies, infrastructure investment is associated with one-for-one growth in GDP, while inadequate infrastructure impedes economic growth.

The Tenth Plan targeted an average GDP growth rate of 8.1 per cent. The actual performance was 4.6 per cent for 2002-03 and 8.3 per cent for 2003-04.

The shortfall is disturbing since the momentum for acceleration, essential to achieve the 8.1 per cent target, is absent.

With GDP growth expected to be around 7 per cent this year, the Plan target is achievable only if GDP growth for the next two years is 10 per cent.

A McKinsey study estimates that addressing impediments to economic growth such as inadequate infrastructure, bureaucracy, corruption, labour market rigidities, regulatory and foreign investment controls, "reservation" of key products, and high fiscal deficits, would enable India's economy to grow as fast as China's, at 10 per cent a year, and create some 75 million new jobs.

It was, therefore, expected that infrastructure would occupy the pride of place in the recently announced Budget. But it appears that the `dream-budget merchant' has not woven innovative dreams for infrastructure development and financing in the ensuing year.

Consider India's road infrastructure — the primary mode of transport — increasingly seen as a major factor influencing economic growth and social development.

India has a very large network of poor quality roads. The 58,000 km stretch of national highways that carries 45 per cent of total traffic, is mostly two-lanes with heavy traffic, low service and slow speeds. Despite the 3.5 million km stretch of roads (the world's second largest), 40 per cent of India's villages have no all-weather access.

Government expenditure on roads accounts for 12 per cent of capital expenditure and 3 per cent of total expenditure, but road maintenance is grossly under-funded, with only one-third of needs being met. This has led to road deterioration, high transport costs and accessibility loss.

While highway length has grown 1.26 times over the last five years (2000- 04), traffic on these highways has increased 14 times.

Even if the Golden Quadrilateral (GQ) project is completed by mid-2005, and the north south-east west (NS-EW) highway project is completed on schedule by 2008, India will have reasonably well-surfaced, four-lane national highways that accounts for just 22 per cent of the country's national highways.

India has 3,000 km stretch of four-lane highways, and no inter-state expressways.

In contrast, China has highway network of over 25,000 km stretch of four or six-lane access-controlled expressways linking major cities, all built during the last decade.

The Centre plans to spend over Rs 2,25,000 crore on highway improvements in the next six years, apart from the substantial investment to connect villages.

In addition, annual expenditure of Rs 7,000 crore is essential to maintain the 1,70,000 km stretch of national and state highways, and further funding is required to maintain urban networks, district and rural roads.

All these expenditures have to be financed within the current fiscal environment of deficits amounting to 9.5 per cent of GDP. In comparison, by 2020, China plans a 35,000 km stretch, $150 billion trunk highway system.

While continuing massive reforms, China's budget deficit for 2005 is expected to be hardly 2 per of GDP. India, therefore, has to grapple with the serious issues of financing the development of highways and other infrastructure , and its structuring. There are two approaches to highway financing — traditional and commercial.

The traditional approach treats roads as public goods, and finances construction from general revenue with little connection between road-provision costs and road-user charges.

The commercial approach treats roads as capital assets, and charges road users directly or indirectly.

In India, the traditional approach largely persists, although national and state fuel cesses, tolls and private financing are increasingly being introduced. Not adopting the commercial approach has contributed to under-funding of road maintenance, and substantial economic losses.

The need of the hour, therefore, is innovative infrastructure financing.

China has been financing infrastructure growth through private domestic investment, multilateral funding and FDI.

The achievement is laudable, when viewed against the backdrop of a relatively weak banking system.

China also proposes to invite cross-border investments from strong global players.

The Budget has proposed some measures for infrastructure financing. Are these sustainable?

Using a portion of India's foreign exchange reserves for financing infrastructure carries the potential danger of fuelling money supply and inflation.

The Inter-Institutional Group (IIG) of Banks can finance infrastructure provided they source long-term funds on a sustainable basis. Besides, the security aspects need to be worked out.

The allocation of Rs 10,000 crore for the year to the new financial special purpose vehicle seems meagre, given the required infrastructure investment.

It is becoming imperative that India look increasingly at private participation, domestic and international, to fund infrastructure growth.

The most attractive option for these private investors would be to use "project finance" — `limited' or "non-recourse" financing of a project through the establishment of a vehicle company. The project financing structure permits multiple equity investors, lenders and long-term contracts with third parties. The risk-return trade-off of long-term infrastructure projects would be rendered attractive through the project and capital structures and the risk management techniques employed. India's strength is its relatively robust financial system. However, use of project financing structures call for:

A sound legal system, since project financing is governed by contracts. Financial regulations and laws have been upgraded but poor enforcement weakens market discipline and integrity.

Involvement of the banking system

World over, bank lending plays a key role in project finance due to its disciplining effect on borrowers' cash flows. However, project lenders should re-orient their skills to assess and hedge the risks of non-recourse lending.

Development of syndicated loan and long-term bond markets to cater to the enormous funding requirements.

Presence of strong insurance mechanisms for risk-mitigation.

Development of innovative financial and hedging instruments tailored for deal structures — hybrid-financing structures, such as mix of corporate and project finance, leveraged leasing structures, etc. Investment bankers would have to upgrade deal-structuring skills, and project capital providers their negotiating skills.

Superior project management capabilities. India's ongoing portfolio performance in the World Bank funded projects is less than satisfactory. China's portfolio performance is the best in the World Bank.

Fast track government clearances/permits/licences/concession agreements, and minimal government interference in project implementation Soon China will adopt innovative private participation models, as is evident by the infrastructure construction plan for Beijing to be implemented from October 1. Infrastructure development has been vital for China — in the 1990s, breaking infrastructure bottlenecks was critical to the sustaining-high-growth-without-inflation strategy; in recent years, infrastructure development has been considered the most effective way of promoting market integration, poverty reduction, and inland China development.

The past has shown that India has innovated best in the face of external triggers. A decade ago, it was the IMF loan that triggered financial reforms. Will China trigger innovation in infrastructure development and financing?

(The author is a finance consultant, and visiting faculty at IIMs. Feedback may be mailed to padmalathasuresh@yahoo.com)

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