Abheek Barua: Infrastructure - A quiet revolution?

Our research team at the bank likes to end the year with a quick survey of the current state of the economy, hoping to get a fix on what the next year augurs. It is hardly a rigorous exercise and consists mainly of talking to companies, lenders, academics, policymakers, and the like. In the absence of resources that one needs to run a serious quantitative survey, I guess it does serve its purpose.

One of the themes that emerged from the survey that we finished last week is that quite a bit is happening in the infrastructure sectors despite the absence of too many visible reform initiatives. Quite surprisingly, there is a good deal of private initiative even in the power sector, where the policy environment remains murky. Except in the case of ports, where there is a fair bit of foreign investor interest, domestic private investors are funding the bulk of these projects.

There is another interesting feature that these projects share across sectors. They tend to be small or medium in size and that naturally limits the amount of capital being deployed in each project. For instance, the road concessions that many private companies are involved in along the highway stretches would span about a hundred to two hundred kilometres. A number of the privately funded power projects are geared to generate between 100 and 250 megawatts of power. Hardly mega projects, by any stretch of the imagination! There is a correspondence between the size of the projects and the profile of the companies involved. A number of them are relatively small, somewhat unknown entities. Some of these companies, however, have begun to make their mark in the stockmarkets as this infrastructure story catches investor attention.

Why is the private sector interested in these projects? For one, the basic economic case for investing in infrastructure in India remains strong. Where else would you find sectors where there is likely to be chronic excess demand for the foreseeable future? The current policy environment (in the power sector, for instance) may not enable producers to charge the prices that one would associate with these levels of excess demand. However, a policy blueprint like the Electricity Act is in place to enable viable pricing in the future and these investors seem optimistic that it will get implemented at some point. Besides, being Indian entities, they seem to have faith in their ability to "work the system" and make sure that despite an unhelpful regulatory regime in some cases, their bottom line is protected.

How sustainable is this boom in infrastructure? Are there enough funds available to support the boom? The sense I get is that in the next couple of years, there are unlikely to be serious glitches. Despite the apparent pressure on bank funds, the large stocks of sterilised liquidity should make sure that interest rates don't rise sharply. The Monetary Stabilisation Scheme, the facility that helps manage short-term liquidity itself, has Rs 67,000 crore parked in it, which can be unwound if liquidity pressures build up.

Besides, a number of companies are still sitting on sizeable cash piles and are beginning to invest some of it in infrastructure. Our estimate of cash profits of the organised manufacturing sector alone in 2004-05 was an unprecedented 6 per cent of GDP. Some firms that have spare cash, for example, are setting up captive power units that would have surplus capacity. These companies hope to sell some of the surplus to the grid in the open access regime.

Besides, public sector entities like the National Thermal Power Corporation will continue to invest a fair bit each year in power generation and that could help improve the supply situation further. The company has strong credentials and if domestic interest rates were to tighten, it wouldn't be too difficult for it to borrow abroad. International rating agencies continue to whinge about the budget deficit levels in India but the fact is that the consolidated government draft on resources has been on a declining trend over the last few years. To cut a long a story short, my understanding is that interest rates are unlikely to harden significantly enough to derail this infrastructure engine.

I have trepidation about the long term, though. It is unlikely that domestic capital alone will prove adequate to bridge the large infrastructure deficit and we need large amounts of FDI. Foreign investors tend to be far more risk-averse than domestic players and need far more clarity on regulation and policy. One of the reasons for poorer risk appetite is perhaps the fact that they are keen on investing much larger sums of money than domestic investors do. In areas like telecom and ports, this clarity and direction seem to be in place.

However, in other sectors like power, the policy environment remains as uncertain and hostile as ever. For instance, despite a de jure "open access" regime, it is de facto unviable to switch supplier because of the high surcharge levied by state regulators. The recent recommendations from the National Advisory Council to jettison the moves to "unbundle" state electricity boards only add to the confusion. The initial attraction of a law like the Electricity Act was that it provided a long-term and somewhat inflexible blueprint for reform. Its perceived inflexibility was seen to iron out uncertainties. Diluting it at every stage certainly defeats its very purpose.

The current state of play in infrastructure suggests that we have some breathing space before the deficit becomes a binding constraint for growth. But there's no escaping the fact that the deficit can be bridged only if the excess demand goes hand in hand with a viable business model for suppliers.

The author is chief economist, ABN Amro. The views here are personal abheek.barua@in.abnamro.com