Urjit R Patel: Sprucing uP inVestments

Instead of bolstering a few projects, long-term funds should be linked to states' reform programmes

Given the sorry state of India's infrastructure, any idea that promises amelioration arouses a fair amount of curiosity and expectation.

The special purpose vehicle (SPV) proposed in the Union Budget 2005-06 is no exception. This article seeks to examine whether and how the proposed SPV could be deployed to give fresh impetus to investments in infrastructure.

One can hardly dispute the finance minister's contention that "the most glaring deficit in India is the infrastructure deficit". Accordingly, the proposal to shore up infrastructure investments by Rs 10,000 crore (with a promise of more in subsequent years, if required), prima facie, seems to be logical.

Moreover, this augmentation is sought to be achieved at as low a transaction cost as possible; the SPV is expected to borrow funds (on the strength of a government guarantee) and on-lend them based on appraisals by an inter-institutional group of banks and financial institutions (FIs).

As an aside, to the extent that the larger infrastructure investments spurred by it would require some imports, the SPV could catalyse a drawing down of the burgeoning foreign exchange reserves. Voila, by all counts, we seem to have a winner!

Now, let us see whether this upbeat picture stands up to scrutiny.

What exactly are these projects which the finance minister refers to as being "financially viable, but, in the current situation, face difficulties in raising resources"?

Put differently, why are banks and financial institutions, which are expected to finance these projects with the aid of the SPV, not lending to them in the first place if they are "financially viable"? Is it because these financial intermediaries do not have enough funds, or, they have reached their sector and group exposure limits?

Or, is it because these projects are not financiable at market rates at which lenders wound normally fund them but could be "made" bankable if the average lending rate is brought down through an infusion of (cheaper) funds from the SPV?

We must seek answers to these questions to help us understand which aspect of the SPV is more important so that we can either "design" a better SPV or seek more effective interventions to rectify limitations.

For instance, if the government finds that infrastructure investments are not taking place due to an inadequacy of debt funds, it could increase the supply of such funds through an SPV, but if this new vehicle taps the same resource pool from which banks and FIs usually raise their requirements, the latter may find themselves crowded out to some extent on the resources side.

(By the way, if the SPV gets into a target mode, it may crowd the incumbent financiers out to a degree on the lending side as well.) It will be interesting to see how the infrastructure financing fraternity reacts to this new-found competition engineered by the sovereign.

On the other hand, if the SPV is mainly meant to make a project bankable by lowering the blended cost of finance, it may be useful to recognise the transaction as such, that is, as an "input/credit" subsidy. (Incidentally, economics tells us that a production subsidy is the best instrument for increasing the supply of a commodity.)

Already the government has opened a slew of (subsidy) windows to enhance the supply of infrastructure services, viz. capital grants for road projects, National Urban Renewal Mission, the investment component of the Accelerated Power Development and Reform Programme, Accelerated Rural Electrification Programme, and Universal Service Fund in Telecom.

It remains to be seen how many of the projects that are eligible for assistance under the above schemes and yet remain unviable, could be made bankable by lowering the blended cost of debt.

After all, in quite a few sectors, the bankability gap at the project level is too large and, more importantly, can be traced back to certain deep, structural maladies plaguing the sector.

Such sectors (and projects) may need an infusion of funds; however, akin to a severely dehydrated person who needs water but cannot just be given a glass of water to drink, they too should be given funds in the right doses and in a structured manner.

Even then, the most dextrous infusion may not save the patient, if the underlying cause of dehydration is left unattended!

The challenge of transforming a sector in a manner that unleashes viable projects is admittedly daunting but not insurmountable.

The Indian telecom sector, the poster boy of our economic reforms, provides an apt testimony to how private investment found its way once the government gave it a half-decent chance to be viable, by simply allowing efficient producers and creditworthy consumers to find (and transact with) each other with little ado.

The successful track record of private investments in ports is yet another case in point. Even the road sector, where a ccomplete recovery of costs through direct user charges is usually fraught with genuine limitations, succeeded in enticing private capital as the government decided to collect proxy user charges (by a fuel levy) and ring-fence them into a non-lapsable Central Road Fund.

In contrast, the private sector has been reluctant to bet its money on (a) the power sector, which still offers little scope for them to directly serve the needs of creditworthy consumers; and (b) a host of urban and rural services, where user charges are inadequate to cover costs and the promise of government support to bridge the consequent gap is seen to be either too low or not credible.

Hard as it may be to believe, in these sectors too, what needs to be done to kick-start a virtuous cycle of investment is well known.

For example, every major committee that has examined the power sector recently has persuasively argued that an early privatisation of the distribution segment is a sine qua non for stemming the rot and achieving a relatively rapid turnaround.

States, however, are dithering because distribution privatisation would inter alia entail taking certain difficult steps, viz. the financing of unfunded (legacy) financial liabilities and losses during the transition period.

In the light of this, if the central government indeed can raise low-cost funds of long-term maturity, it could perhaps use them best to aid states in meeting the aforementioned financing requirements, provided they agree to a credible reform programme, i.e. an expeditious privatisation of power distribution under a multi-year price-cap regulatory regime, ring-fencing of the subsidy support meant for rural areas, and awarding the same through minimum subsidy bidding.

To sum up, the ability of the central government to raise (long-term) funds at the finest rates is unique and precious. It would be a pity if this advantage is frittered away in easy but unsustainable quick-fixes such as artificially bolstering the viability of a handful of projects.

Ideally, the central government should harness this advantage to help states embrace the right kind of reforms in power and urban infrastructure and unleash genuine sector-wide public-private-partnership opportunities that the Prime Minister recently alluded to.

This is not an entirely unreasonable expectation from a government that has enormous brainpower at its helm and avows that its heart indeed beats for Aam Admi.

The author is with IDFC; the views expressed here are personal

urjitpatel@idfc.com