Funding India's infrastructure gap

The finance minister recently outlined an ambitious Rs 102 trillion plan to boost India's infrastructure. Like many previous announcements, the plan was loud on intent but mum on critical economic details. Specifically, no insight was provided on how the central government would fund the Rs 40-odd trillion that it has committed to contribute. Neither have details been shared about what was driving the government’s confidence in assuming that private players would be willing and able to invest close to Rs 20 trillion in India’s infrastructure over the next five years.

 

Mobilising funds for transformational infrastructure development has been a challenge the world over. Investing in infrastructure carries unique risks which are made all the more peculiar in India owing to the weakness of our institutions and the fractured nature of our polity. Infrastructure projects are lumpy, difficult to diversify, long in gestation and illiquid. This makes infrastructure investments unfeasible for most investors except for patient capital that is not excessively risk-averse. Such investors are rare. Moreover, as the recent brouhaha over Amaravati shows, infrastructure projects in India also carry a significant political risk premium.

 

The government faces two challenges in funding its infrastructure push. One, with government finances stretched to their limit and the economy slowing, it has little fiscal space to fund infrastructure projects through budgetary allocations. Second, the private sector’s appetite for infrastructure projects is probably at an all-time low and it is unlikely to commit the quantum of funds that the government is assuming. However, these problems are not insurmountable if we learn from the experience of China and South Korea.

 

At the beginning of its economic miracle in the early 1990s China faced a similar gap between infrastructure aspirations and finances. In a detailed paper, George E Peterson of the World Bank explains how China transformed its infrastructure by employing a land lease model [Land Leasing and Land Sale as an Infrastructure Financing Option (2006)]. This model originated in Hong Kong and was later adopted by the Chinese government.

 

To raise funds for infrastructure development, Chinese municipalities used their land bank. Land development rights were sold outright to private parties on long-term leases, or, in many cases, realising that the development of infrastructure would enhance the market value of land, the government issued debt secured by land and repaid it by selling land parcels at enhanced prices after the project was complete.

 

Unlike China, all land is not public in India. Even so, the Indian government is sitting on large swathes of land that can be leveraged to fund infrastructure projects. By some estimates, the Indian Railways alone has a land bank of 12,066 acres of surplus land, which can be developed to fund capital expenditure. Additionally, urban development authorities in India can also acquire land and sell development rights to fund infrastructure just as the Mumbai Metropolitan Region Development Authority did quite successfully with the Bandra Kurla Complex.

Investing in infrastructure carries unique risks the world over, but they are all the more peculiar in India owing to the weakness of our institutions and the fractured nature of our polity
While this model is attractive, safeguards will have to be instituted to protect the interests of current land owners/users and to ensure that land revenue is used exclusively to fund infrastructure and not operational inefficiencies. Specifically, the interests of landless and tenant farmers need to be protected. This can be done by using land pooling schemes which give landless and tenant farmers a permanent stake in the assets of the pooling agency. Creation of such pooling agencies, as distinct from municipalities, will also ensure that these funds are used only for infrastructure development and not pilfered or wasted by local corporators.

 

While China has implemented a state-funded model of infrastructure development, South Korea upgraded its infrastructure largely with the help of private capital. Since private investment in infrastructure is unfeasible for most risk-averse investors, the Korean government introduced measures to de-risk the projects for private investors in order to attract more capital. This is particularly salient for India, where infrastructure projects are riskier than those in other parts of the world owing to our unique institutional political structure.

 

Specifically, the Korean government undertook two steps to make infrastructure investment feasible for private investors. In order to de-risk revenue uncertainty from infrastructure projects, the Korean government offered minimum revenue guarantees which assuaged concerns of project feasibility in the minds of private investors. Secondly, it set up a Korea Infrastructure Credit Guarantee Fund to enhance the credit of infrastructure projects, thereby encouraging private lending for these projects.

 

Given the reluctance of private capital to participate in infrastructure projects in India, these are steps that the government will have to take urgently if it is to meet the funding target for its ambitious infrastructure push. In fact, it could be argued that de-risking revenue uncertainty and credit guarantees will not be enough to attract private investment in Indian infrastructure. Steps will also have to be taken to insulate infrastructure projects from political shenanigans and administrative bottlenecks and harassment.

 

One way to mitigate the political and bureaucratic risk to projects would be to follow the Korean model and institute a put option in infrastructure projects, where the concessionaire has the right to request a government buyout of the project at cost if it is terminated or delayed owing to non-economic factors.

 

Overall, while the government’s intent on infrastructure development is commendable, it is unfeasible in the current economic and regulatory climate. If India is to have a truly transformational infrastructure push, it will have to leverage resources like land and deploy innovative financial structures to attract private capital.   

 

 



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