A Tonic for India’s Infrastructure Financing Woes: Global Capital Markets

For India to continue growth on a sustainable path—investment in infrastructure is critical. Infrastructure bottlenecks are seen as one of the leading obstacles for India in realizing its economic growth potential. India’s information technology (IT) industry positioned India as global player, and grew with access to good telecommunications infrastructure sparked by a liberalized telecom market. But inadequate infrastructure—unreliable power supply, poor roads, and constrained airports—retards firms’ ability to scale up and limits foreign investment.  In the paper “Complementing Economic Advances in India: A New Approach in Financing Infrastructure Projects” by SMU Cox Finance Professor Andrew Chen and co-author Jennifer Warren Kubik, a solution is offered which has significant implications for capital markets and development beyond the infrastructure project itself.

Indian Prime Minister Manmohan Singh estimated that $320 billion was needed for infrastructure development by 2012. Rajat Nag, managing director of the Asian Development Bank, suggested $500 billion was needed during the period. Regardless of the vast sums required to finance projects, private capital will definitely be required. India, with its infrastructure challenges, could benefit from a new approach that attracts needed financial resources through the invisible hand of global capital markets.

A New Approach
The proposed global capital market approach coupled with financial innovations could help smooth the frictions which lie at the root of India’s infrastructure development problems. India holds great interest among capital-rich, developed-country financial markets seeking investment opportunities and in developing countries positioning themselves in the global economy. Infrastructure spending in India is particularly politicized and could gain efficiencies through the benefits of global capital markets rather than at the hands of political agendas.

The basic idea is to raise capital through initial public offerings (IPOs) and securitizations globally for infrastructure projects and/or funds which specialize in certain sectors, such as power, water, roads, and so on. This approach can also complement the growing trend of infrastructure funds being developed worldwide. The private sector’s ability to attain efficiency in operations and management and profitability has been needed for numerous financial and economic reasons (often public debt or mismanagement) in countries which are privatizing public works assets—roadways, airports, and both power and water utilities.

A critical motivation for this research is that current approaches in financing infrastructure projects often lead to inefficiencies in negotiations, bidding processes, project costs—and often corruption. In many developing countries, political or policy risk may be faced by a foreign company with the possibility of significant capital losses when policy reversals or public “mood swings” occur. The Enron project, the Dahbol power plant, provides an example of the many inefficiencies and risks which can occur in an infrastructure project. While a $2.9 billion project fell apart, the economic opportunity cost to the Indian economy and consumer and what might potentially have been accomplished weighs in. The paper also analyzes the Enron case in tandem to the proposed new approach. Red tape is often cited as a phenomenon which hinders business opportunity; the market approach can help circumvent  the tendency toward bureaucratic fiefdom and mitigate other poor policy choices.

A Problem of Plums
Chen coins the term ‘plums problem’ in infrastructure projects. The problem of plums arises when project companies bidding on a project have greater knowledge about a project’s value, risks, and costs in relation to the seller (government). With this specialized knowledge, the buyer (project company) can take advantage of the situation. This is an opposite notion as in the case of Akerlof’s illustrious lemons problem, where the buyer is disadvantaged.  The plums story continues to repeat itself over and over in many an infrastructure project worldwide.

Using capital markets to overcome many of the shortcomings of existing approaches—both the BOT (Build-Operate-Transfer) and the popular PPP approach (Public-Private Partnerships), a better way to finance needed projects can evolve.  In the case of India, this would create diversification, liquidity, and eliminate the plums problems that accompany the existing BOT and PPP approaches in financing infrastructure projects. It would also begin to unravel the perverse incentives pervading infrastructure spending in India. The tools available in today’s globalized world will allow developing countries to benefit as advanced economies have in raising capital and promoting projects or companies. This approach would bring true private sector participation for economic development and legitimize further business activity.

In Conclusion
While a good deal of media coverage and academic papers discuss India’s infrastructure woes, this paper details the problems inherent in projects and current approaches and offers a solution. This approach also couples financial innovation to mitigate downside risks and capture upside potential of projects and economic events. If adopted in some form, the capital market approach may give tailwinds to developing countries in a way never before possible. Having the basics “covered”—infrastructure being the foundation—can lead to further economic development, increased standard of living, and enhanced participation in the global economy. Thus, India would serve as a model country in adopting a modern approach for financing its far-reaching agenda of infrastructure development.

The paper “Complementing Economic Advances in India: A New Approach in Financing Infrastructure Projects” by SMU Cox Distinguished Finance Professor Andrew Chen and co-author Jennifer Warren Kubik is forthcoming in Journal Of Structured Finance.