India’s current physical infrastructure deficit is alarming. In 2009, India spent 6.5 per cent of its gross domestic product on infrastructure, compared to 11 per cent by China. While the demand for infrastructure investment in India is enormous at the current GDP growth rate, the public and private supply of investment has been dismally low.
According to preliminary estimates provided by the Planning Commission, at current prices Rs. 12.7 trillion in infrastructure investment is required in the remaining two years of the Eleventh Five Year Plan (FYP). Of this, it is estimated that 45 per cent will come from budgetary resources, and the remaining from debt (commercial banks, non-banking financial companies, insurance companies and external commercial borrowings) and equity (including foreign direct investment). Taking estimated requirement (as per the existing funding pattern) and estimated availability (as per trends) of debt and equity sources into consideration, a funding gap of Rs. 1.28 trillion over the next two years has been identified.
The challenge is going to further accentuate over the Twelfth FYP (2012-17), with a projected investment requirement of more than $1 trillion (at 2006-07 prices) by 2016-17. This would imply an annual infrastructure investment of $200 billion — a truly staggering figure.
The rapid pace of urbanisation (according to UN reports, the Indian urban population will increase by 2.3 per cent per annum between 2010 and 2025) will only add to the challenges of infrastructure development and its financing. A recent McKinsey report projects that by 2030, India will have 68 cities with a million-plus population, 13 cities with more than four million people, and six mega cities with a population greater than 10 million, two of which will be among the five largest cities of the world. The same report puts just the urban infrastructure needs (transportation, housing and office space) at $2.2 trillion by 2030.
In the above context, it is quite evident that bridging the financing gap will require active involvement of both the public and the private sector. In India, despite continued emphasis in the Plan documents on the public-private partnership (PPP) model as an alternative route of developing and financing infrastructure, the private sector response has been less than modest. Since infrastructure projects are typically characterised by non-recourse or limited-recourse financing, long gestation periods and low and uncertain risk-adjusted returns, attracting private investment continues to be a major challenge.
From a policy perspective, reforms are needed at various levels.
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First, the relevance of the IIFCL (India Infrastructure Finance Company Limited), a special purpose vehicle set up in 2006 for providing long-term financial assistance to infrastructure projects, needs to be reviewed. It is an enticing but flawed financial engineering mechanism.
The IIFCL has been mandated to refinance 60 per cent of commercial bank loans for PPP projects in critical areas, in turn raising the required money through issuance of government-guaranteed, tax-free bonds. Since the IIFCL itself primarily sources its funding requirements from banks, and subsequently refinances banks for their lending, it substantially increases the cost of finance. There is little rationale for such an arrangement of financial intermediation. The counter-guarantee by the government only increases the contingent or off-budget liability, and though the borrowings are not reflected in the account of the government, its consequences are akin to running an actual fiscal deficit. Besides, the IIFCL mostly lends to government-backed projects (lending to private sector projects is limited to 20 per cent of total lending in an accounting year), and has a relatively small capital base. Also, the IIFCL should come under the regulatory purview of the Reserve Bank of India, rather than the current sui generis mechanism of regulation by the government.
Second, while the initiative to create a secondary market for debt instruments through the newly proposed India Infrastructure Debt Fund (with an initial corpus of Rs 50,000 crore) is a welcome step, given the overall nepotistic and unhealthy investment climate prevailing in many states and urban centres across India, its success is less assured. Pension and insurance funds will be less willing to park their assets in the fund if viable infrastructure projects are not identified and/or where user charges are not realised.
Third, over the medium- to long-term, there is a need to reduce over-reliance on the banking system for infrastructure funding. A strong focus is required to develop a deep and robust corporate bond market, which would also help banks address their asset-liability mismatches. Companies should be allowed to float and trade corporate bonds for project-related purposes.
Compared to other emerging countries in Asia, India’s stock of listed non-public sector debt is relatively illiquid, estimated at a meagre 2 per cent of its GDP. Therefore, India needs to graduate towards a more mature, long-term capital market, which supports an optimal capital structure in financing infrastructure. As proposed by Assocham, minimisation of issuance costs and the time taken to make public issues, along with rationalisation of stamp duty on bonds, could potentially lead to a more liquid corporate bond market in India.
On a related note, the prime minister’s call for public scrutiny and quarterly monitoring of infrastructure targets and achievements is a big step towards improving transparency and accountability in this area, and should be welcomed.
The author is associate professor in economics at the Goa Institute of Management, Goa. The views expressed are personal. amarendu@gim.ac.in