Executive Summary:
It's not often in a lifetime that an idea comes along which could have widespread implications for the global economy, as illustrated in the case of one very important country. In "Paving the Path For India's Growth" by SMU Cox's Andrew Chen and co-author Jennifer Warren, published in Far Eastern Economic Review, the authors call for a greater role for capital markets in India's infrastructure drive.
In the last several years, India's central and state governments have put forth the message to the international investment community that India's infrastructure sector is open for business. In 2007, high-level meetings between Indian and United States officials and executives have sealed investment deals with the likes of Citigroup, General Electric Co., Macquarie, and Deutsche Bank, and a few others, of nearly $16 billion. But the Indian government estimates they need to raise roughly $500 billion by the end of 2012 to sufficiently upgrade roads, ports, and airports and acknowledge - "infrastructure bottlenecks are emerging as the single most important constraint on the Indian economy."
About Infrastructure
The nature and characteristics of infrastructure projects are inherently risky. Large-scale projects require massive capital investment with long completion times, thus carrying political and regulatory risk. In India, cases of corruption and political and economic risk make investors hesitate as in the Enron-Dahbol power plant project. The Enron power plant in Maharashtra state still looms large in investors' psyche. The $2.9 billion project was doomed by bad contracts, politics, and economic circumstances.
India's infrastructure sector has been characterized as "being led by contractors and players in the trades," according to findings from a 2007 infrastructure conference in New Delhi. In India, power projects, roadways, and improved sanitation top the list of critical priority infrastructure needs. Airports and seaports are estimated to require $15 billion and $17.5 billion, respectively, over the next several years. Where will India raise the massive funds for infrastructure? As a response to its challenges, the Indian government is promoting public-private partnerships (PPPs). One objective of the Indian government is an increased role for the much-desired financial investor to re-align economic incentives, which PPPs are meant to do.
But the approaches of PPP and BOT (build-operate-transfer) have some severe flaws that a more market-oriented approach could solve. These two approaches to infrastructure finance suffer the "plums" problem where the buyer (bidder or firm providing capital) often knows more about the quality and economic value of the project than the seller (government agencies). Having better knowledge of the project's costs and value gives incentives for political games, corruption and waste.
With current the "contract finance" approaches of BOT and PPP, the bidding process is often inefficient. The National Highway Authority of India has been a case where the competitive bidding process had historically been sabotaged by politics and special interests. Inefficiencies show up in negotiations and bidding processes which require lengthy amounts of time and effort for completion. India has a reputation for bureaucratic red tape, especially in more economically-lagging regions which tend to have more entrenched local political and business interests.
Policy risk-the risk that a government will discriminatorily change the law, regulations, or contracts governing an investment-is a problem for investors and consumers in both developed and developing countries. High bids are noted in port projects in India due to policy risk. Examples of policy reversals show up in countries worldwide though, from the Philippines to Thailand to a private toll-road project in Dallas, Texas. The two approaches also suffer from a lack of diversification and liquidity.
A Matter for Markets
Global capital markets offer a viable source of diverse funds, promote better governance, and can bring efficiency and transparency to the infrastructure puzzle. The experiences to date with privatizations and securitizations suggest that a "market finance" approach, which creates immediate private ownership of public-investment projects among diverse groups of investors, may lead to more efficient and successful infrastructure development.
In this truer form of public-private partnership, government focuses on identifying and facilitating the project and then allows the private sector to create an efficient, sustainable public works asset that offers a financial reward to risk-takers and its owners. In India, with contractors and the trades leading project development versus investors, incentives of a plums nature exist.
Project securitizations or initial public offerings of project securities can be designed with financial innovations for any new large-scale infrastructure project. This would create diversification, liquidity, and mitigate many of the problems that accompany existing approaches in financing infrastructure. It would also begin to unravel the perverse incentives in infrastructure spending in India, and foster transparency. Financial innovations in the securities offering can serve as both a policy risk deterrent and an incentive. In the end, the explicit costs of debt financing for infrastructure would be lower.
An Impetus for Good Policy
Of great consequence, the invisible hand may prove more capable in setting infrastructure project agendas which span varied administrations and political agendas. Progressive ideas are emerging across the development spectrum in India. With respect to the land acquisition problems faced by India, farmers in Maharashtra and an industrialist are setting up a visionary SEZ (special economic zone), whereby farmers become stakeholders and shareowners in the opportunity in a village 40 km from Pune.
The appearance of many diverse stakeholders-foreign investors, governments, and domestic investors and consumers-can further catalyze the reforms India needs. Prior methods of infrastructure project finance have worked, but at costs hidden to society. India with its infrastructure challenges represents a "greenfield" opportunity for a new approach that would attract the financial resources for sustainable development-and be more inclusive for India and its citizens in the global economy.
"Paving the Path for India's Growth" by distinguished finance professor Andrew Chen and Jennifer Warren of the consultancy Concept Elemental, was just published as the lead article in Far Eastern Economic Review, March 2008. |
