The Hindu Business Line : Pumping up the infrastructure sector

Faster progress on infrastructure largely depends on both effective demand for projects and proper usage of funds. What is required is a policy that can protect the interests of consumers and simultaneously create healthy competition between the public and private sectors, by encouraging the latter to invest through better regulatory and delivery mechanisms.

INFRASTRUCTURE plays a crucial role in a country's economic development, by enhancing productivity and improving competitiveness. In India, not much progress has been made on the infrastructure front. This is despite some measures initiated in the past few years to give the sector a leg-up.

This year's Budget, like the previous one, has proposed some measures specifically for infrastructure, such as a special purpose vehicle (where the borrowing limit will be Rs 10,000 crore a year) and an enhanced allocation of Rs 1,500 crore for the viability gap fund. But mere allocation of funds will not solve the infrastructure problem.

From India's own track record and the progress made by some of the developed and developing countries, it can be said that faster progress of infrastructure largely depends on both effective demand for projects and proper usage of funds. Many South-East Asian countries, and even developed countries such as the UK, have shown impressive progress by following the public-private-partnership (PPP) model.

In India, considering the huge investments required for infrastructure, it would be ideal if greater emphasis were given to framing policies/regulations that encourage PPP in different projects in the sector.

Generating investment demand

Often, the private sector is unwilling to invest in infrastructure projects. At present, however, the problem seems more to do with inadequacy of good projects. Hence, there is a demand-side effect. The private sector will get involved if a payment mechanism that reflects cost of providing infrastructure is in place. Budget 2005 has not addressed this issue.

Another major reason for poor private sector participation is the regulatory environment. There is an urgent need to create independent regulatory authorities for ensuring a level-playing field, especially in the road, water, port, and oil and gas sectors. The independent regulators should be transparent and enjoy autonomy in framing sector-specific policies. One of their major tasks would be to usher in healthy competition. The required policy guidelines must be framed as early as possible.

Rationalisation of prices is another important issue. For any infrastructure project, particularly those relating to road and water, the Government has to first identify the customers who will pay for them. For this, mechanisms such as the "private finance initiative" followed in the UK, Australia and Chile may be followed.

The Government must also develop a pricing mechanism through tariff or other means, by strictly adhering to the "User Pays" principle. This would ensure at least minimum viability of any potential private investment. On this front, some progress has been made in the telecom and power sectors.

The revenue collection mechanism of projects also needs to be strengthened. In the road sector specifically, the Government should demonstrate some alternative ways to levy user charges and involve the private sector in improving the quality of service.

Considering the importance of the infrastructure in economic development, targeted growth rates need to be fixed for the sector. And to achieve this, the Government should identify some big projects in 2005-06 and treat them on a fast-track basis.

Budget 2005 mentions only the NHDP-3 project in the road sector. Though some funds has been allocated for the project, no timeframe has been set for completion. While announcing fast track projects, the Government should spell out the amount of money to be allocated for each of them through the viability gap funding route and the approximate time limit for completion.

Also, for quick completion of the projects, some more fiscal incentives, such as duty-free import of capital goods, are required. The Government could also introduce a special section in the I-T Act that made investments in infrastructure projects tax-free. This would encourage private players to invest more in this sector and, thereby, ensure speedy completion of projects.

As foreign direct investment (FDI) is a major source of finance, the Government should fix annual FDI targets for the sector.

Supply of funds

As regards project financing, Budget 2004 had announced the setting up of an inter-institutional group, which was supposed to pool in Rs 40,000 crore for infrastructure funds. However, not much progress has been made on this front. Thus, the proposal of an SPV with Rs 10,000-crore borrowing limit will not serve the purpose. One, it will be a time consuming and, two, it will add to the fiscal deficit.

Proper channelling of project funds is another key requirement. In this context, the supply of funds, especially on project-financing basis, is broadly determined by a) allocation of risks between equity investor, the lender and the government; and b) the availability of instruments to match the specialised financing needs of infrastructure, which varies from project to project depending on its cash flow streams.

Considering the two aspects, a risk-allocation mechanism between the public and private sectors must be developed. This will ensure that risk is allocated to the party that is able to control it best. Both the Government and policymakers will have to device different types of risk mitigation/sharing models suitable for different types of projects. In some cases, it is possible to transform un-diversifiable risks to manageable ones by the using least present value of revenue (LPVR) auctions, especially in highway projects.

Rather than an SPV, it would have been better if the Government set up an "Infrastructure Development Fund", the corpus of which can be raised from sources such as disinvestments, taxing the agricultural income of richer farmers, raising more tax revenues from the services sector, and floating long-term infrastructure bonds by offering a low coupon rate of, say, 2 per cent, with no upper limit for investment or disclosure of sources of income. At the time of maturity, only normal I-T rates should be applicable. This will help channel more black-money into the system and, simultaneously, the Government's cost of borrowing will be minimum and it can be extended for a longer term.

As regards forex reserves, it may not be an ideal source for financing infrastructure projects. As most of the forex reserves are in short-term assets, using these for long-term infrastructure projects will create asset-liability mismatches. This apart, the projects themselves will not be forex earners. In addition, with the country moving towards full capital account convertibility, there may be more pressure on the forex reserves.

So, to ensure greater flow of funds to infrastructure at cheaper rates, the Government should declare that all infrastructure financing by banks will be treated as priority sector lending. This will be a win-win situation for both banks and those seeking project funding.

Considering the long-term requirement of funds, some structured long-term products — pension funds, for instance — may be developed. The Government should also facilitate trading of debt instruments, which are still at a nascent stage in the country. Though the Government has taken some initiatives to develop the debt market in this Budget, it is not sufficient considering the huge requirement of funds. The Government may, therefore, think of establishing/promoting an organisation for debt trading, with initial liquidity provided by it and some big banks. Once the initial boost is given, the chances of trading picking up would be better.

International experience shows that there are many subtle problems in finding the right infrastructure policy framework. India is also no exception to this. What is required is a policy that can protect the interests of consumers and simultaneously infuse healthy competition between the public and private sectors, by encouraging the latter to invest through better regulatory and delivery mechanisms. This will help in the faster growth of this sector.

(The author is Assistant General Manager, IDBI Ltd. The views are personal. e-mail: subhasish662003@yahoo.co.in)

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