Vinayak Chatterjee: The growth driver of the 21st Century

INFRATALK

Infrastructure with private capital is clearly the global growth driver. China and India occupy centre stage.

In the temples of infrastructure, the Macquarie Group is clearly one of the high priests. This visionary Australian company has a pre-eminent position in various segments of infra-development worldwide. So, when the Macquarie Research Report on Global Infrastructure (May 2008) hits the stands, infrastructure players and observers take keen interest.

The report sets out the current global perspective by pointing out that governments, increasingly faced with growing deficits and other demands on spending, are struggling to keep up with the growing demand for infrastructure investment. For instance, government spending on infrastructure in OECD countries (Canada, Australia, France, Germany, UK, and USA) dropped to 2.2 per cent of GDP in 1997-2003 from 2.6 per cent in 1991-97. Across the globe, the increased need for infrastructure investment and the decline in government spending has created a unique phenomenon "" the "infrastructure-investment gap".

In 2003, the OECD published data on actual expenditure, as compared to the needed expenditure for infrastructure as a percentage of GDP. 
  

THE INFRASTRUCTURE DEFICIT
Infra Spending As % of GDP	Low Income Countries	Low-Middle Income Countries	High-Middle Income Countries
Needed	8	5	3
Actual	4	3	2.5
Gap	4	2	0.5

The investment gap is particularly wide for developing economies. Interestingly, it is also creating a huge market for private capital to move in.

From a public investment perspective, the key culprit behind this 'infrastructure-investment-gap' is the mismatch between the political, budgetary and infrastructure development cycles. For example, a road has an economic life of around 30 years and a planning period of 10 years. This is clearly at odds with a typical business cycle of seven years, political cycle of three to five years and budgetary cycle of two to three years. Thus, difficult short-term political sacrifices are needed to ensure that, in the long term, the state adequately meets its infrastructure needs. Politicians, usually loath to raising more and more taxes, constrained on fiscal deficits, and overwhelmed with social-sector deliverables, are increasingly looking to the private sector.

Historically, governments in developing regions have themselves funded about 70 per cent of infrastructure investment needs, with 22 per cent funded by the private sector and 8 per cent by official development assistance. According to the World Bank, private investors contributed $580 billion to more than 1,900 infrastructure projects in developing countries from 1990 to 1999. This figure was estimated to be 3.5 times the total amount the Bank lent to developing countries over the same period.

The trend towards privatisation of infrastructure has increased opportunities for private investors. Private players are participating in designing, building, advising, financing and maintaining infrastructure assets alongside governments, like never before.

Private investment in infrastructure is occurring via the following routes:

Full private provision (FPP): In this case, the government transfers complete ownership of the asset to private players. The government assumes no responsibility of risk.

Public-private-partnership (PPP) schemes: In the case of PPPs, the investment is funded and operated through a partnership between the government and one or more private sector players.

Private finance initiative (PFI) schemes: PFI schemes introduce the benefits of private sector management and finance into public sector projects. It differs from privatisation as the responsibility of providing essential services to the public is not transferred to the private sector; nor is asset-ownership transferred.

Macquarie Research (Equities) has identified around $90billion of equity (up 80 per cent on last year) currently held in various unlisted funds that is destined for infrastructure investments globally. This $90 billion of new money in private funds looking to be invested, comes in addition to the potential for direct investment from pension funds and additional investment from listed companies with a total market capitalisation of $1,767 billion.

Demand for infrastructure assets is at an all-time high. The real challenge for the sector is the supply of quality assets. Thus far, the number of new deals coming to market has not kept up with the growth in demand "" particularly in developed markets. Tellingly, more than $16 billion of Indian infrastructure-specific fund raisings were announced in the first four months of 2008. For India, a transparent PPP model, comparative lack of foreign investment restrictions and promotion of private investment is finally 'paying off' in the form of significant inflows of capital to Indian infrastructure funds. Most of the discussions in India now are about "lack of bankable projects", and the opportunities (or lack thereof) to channelise these funds into viable projects.

The Macquarie research team postulates that significant private fund interest in Indian infrastructure investment is not paralleled in China. Restrictions on foreign ownership mean that foreign investment in China is predominantly though listed entities, and consequently the quantum of new investment funds being raised in China is lower than in India. China has developed a novel, albeit protective, model for the financing of public infrastructure projects that is applied to many projects in the sector. It is essentially a partnership model, whereby the government owns a corporation as a shareholder, together with private entities (including foreigners) and local governments that have an interest in the particular venture. Later, these corporations may be taken public. In most sectors, there is a restriction on the amount that foreign entities can invest in Chinese infrastructure. Thus, investment must be by way of partnership, or through a listed entity.

Contrasting this more restrictive position in China, India is very open to the notion of foreign investment in infrastructure, and welcomes multinational developers, private equity funds, international sponsors and domestic firms. Consequently, while there is nominally more money going into the infrastructure sector in China, the opportunities for foreign investors going forward are heavily weighted to India.

The Report goes on to an elaborate comparison of India and China's infra-development track record. From the beginning of its 1st Five-Year Plan in 1953, China has spent up to 28 times what India has on infrastructure investment in successive plans. Between 1996 and 2005, China spent 8 per cent of its GDP on average on infra-development. This relatively high rate of investment in infrastructure was almost certainly a contributor to China's GDP growth rate, which increased at a CAGR of 11.4 per cent during the 1996-2005 periods. However, while China took an early lead in infrastructure development by investing heavily in the 1990s, India is catching up in the 2000s.

The dragon and the elephant (or is it the tiger?) are both dancing the 21st century infrastructure dance!

Vinayak Chatterjee is the chairman of Feedback Ventures. He is also the chairman of CII's National Council on Infrastructure. The views expressed here are personal