The Indian Economy Blog

November 5, 2005

How About A New White Elephant To Fund Infrastructure?

Filed under: Banking,Fiscal policy,Infrastructure,Regulatory reforms — Nitin @ 8:43 pm

More of the same where the same has failed

Here’s a conundrum: it is amply clear that given the abysmal state of India’s roads, railways, ports, irrigation and electricity grids, and given the rapid growth of the Indian economy over the past several years, good infrastructure is in great demand in India. Yet the central government’s infrastructure financing vehicles have been unable to disburse the allocated funds for the lack of financially viable projects. Understanding this unusual state of affairs is important, even critical, to be able to solve one of the Indian economy’s most pressing problems. Unfortunately though, the UPA government’s latest proposal to address this problem shows every sign of poor diagnosis and equally unimaginative solutioning.

Infrastructure projects are not taking off in India in a big way not because there are inadequate sources of capital, but because government policies make it impossible for many projects to be financially viable. First there are regulations that firmly put several industries out of the private sector. The state runs the railways, almost all of the India’s power industry and dominates the aviation sector. Road projects are hampered by overlapping local, state and central government regulations. If the state were to roll back its choke-hold even a little — as in the case of telecommunications and to a lesser extent in civil aviation — it is clear that market forces can successfully provide quick and competitive solutions.

And then there is that admixture of socialism and populism that destroys the price-mechanism. Electricity pricing is not based on costs of production or on market demand. Instead it is based on electoral necessities. Railway ticket prices do not even account for inflation. Air tickets are the government’s way to rob the rich and pay airline employees. While there is hardly a party in India’s political spectrum that dares to challenge these perceptions and point out that good infrastructure cannot be free, the UPA and the Left are the worst of the lot.

The solution to India’s infrastructure shortfall, therefore, lies in deregulation and movement towards a market-based infrastructure industry. As the Economic Times suggests, the government could well have developed greater sophistication in bond markets to aid the flow of capital into the infrastructure sector. Instead, the UPA government has created yet another ‘special purpose vehicle’ to fund infrastructure. The India Infrastructure Finance Company (IIFC) will borrow from international financial institutions and lend to ‘deserving’ infrastructure projects. This is a doubly dangerous. The government, and not the market, will choose which projects are funded. And governments have a poor record on this front. And since the central government is underwriting the international borrowings of the IIFC, it will have to repay lenders from its own revenues in case the projects it picked run into difficulties.

Despite throwing about fashionable terms like ‘public private partnerships’, it is clear that the UPA government has thrown up a lazy and very likely an ineffective solution due to its fundamentally mistaken belief that India can solve its infrastructure problems without further freeing up its economy. No wonder then, that among India’s leading newspapers, it is only the leftist Hindu that is cheering the move.

21 Comments »

  1. [...] eading newspapers, it is only the Leftist Hindu that is cheering the move. This post also appears on The Indian Economy Blog

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    Pingback by The Acorn » How about a new white elephant to fund infrastructure? — November 5, 2005 @ 8:45 pm

  2. Nitin,

    The perfect cannot be the enemy of the good. Private sector investment in infrastructure is inhibited by many factors – contracting problems, unclear and conflicting regulation, lumpiness and riskiness of investment, populist pressure. We can either wait to usher in utopia where these problems will all go away and the private sector will deliver the investment. Or we can be realistic and consider that these issues exist even in developed democracies and the government can take the lead where the private sector fears to tread. Finally, public investment stimulates private investment and especially FDI – look at China. What does it matter whether a mouse trap is red or blue as long as it catches mice (apologies to Deng!!)

    Except for the US, I am hard pressed to think of a large-sized country where the private sector led infrastrcuture development.

    Comment by Amitabh — November 5, 2005 @ 9:24 pm

  3. Amitabh,

    I think India has an example in the telecom industry. Withing three years of deregulation, India has two new national fibre-optic backbones, several mobile operators who cover most cities and towns, over a thousand times more international submarine capacity etc. Tariffs have come down significantly.

    There is considerable room for improvement (on the regulatory front), nevertheless telecoms is a successful example of private investment doing the unthinkable. Even with the kind of deregulation that was carried out, the results are still impressive.

    Comment by Nitin — November 5, 2005 @ 11:43 pm

  4. There is a difference between the telecom scenario and with building an infrastructure: The Rate of return of the investment is much different and lower when it comes to an infrastructure. Unless there is a high return factor, private ventures have no business with it and don’t want to clog their finances into something that will take a longer period of time to be redeemed.

    I am working with the Indian Institute of Technology on building the digital network to connect the administrative offices of the government and have a first-hand taste of the situation.

    If you want to know more, you can mail me at the address below.

    Vijay
    vijaysanand2003@hotmai.com

    Comment by Vijay — November 6, 2005 @ 1:42 am

  5. Sorry. Email address correction.

    It’s vijaysanand2003@hotmail.com. My apologies.

    Comment by Vijay — November 6, 2005 @ 1:43 am

  6. Vijay,

    “Infrastructure” includes power, transport, irrigation, communications etc. Of course, no two sectors will have the same business case; ditto within each sector. But they are all similar as they involve large upfront capital investment with returns spread over long periods of time. The assets itself have long economic and physical lives.

    You are right about the return factor. Infrastructure investments are usually low risk, with lower returns on investment (compared to say portfolio investments in stocks). At the risk of oversimplifying, infrastructure investments must offer a rate of return better than the safest other investment (like long-term government bonds).

    Because telecom is both a infrastructure and service industry, investors have an opportunity to recoup their overall investment in a shorter timeframe. Investment in basic infrastructure (like underground ducts, fibre-optic networks etc) is not unlike investment in building a power grid or road network. Returns are lower and slower. Because the same players also run mobile and other services (which have higher and faster rates of return), it makes business sense to invest in telecom.

    This suggests a good model for power, roads etc; i.e., government policy should aim give investors opportunity to balance their investments.

    Comment by Nitin — November 6, 2005 @ 7:03 am

  7. I stand corrected that the term “Infrastructure” denotes more than the network that connects the government services together to make them function efficiently. Though I know it in my mind, it was still an incorrect term to use. I agree that would be the IT infrastructure.

    I guess everybody is greedy that nobody wants to wait long for their finances to fetch them a better rate of return. Or maybe all of us Indians have lost hope on an orderly India that the idea of investing on Infrastructure seems as good as an idea as throwing all that money into the ocean and forgetting about it.

    The percentage of individual investors in India is very low that, the infrastructure that does not follow the trend of a “Hot investment” escapes the radar of investment possibilities, quite easily.

    There is an article written by a NY VC Fred Wilson on his blog about this same topic.

    Comment by Vijay — November 6, 2005 @ 11:40 pm

  8. The Indian government set up the Industrial Development Bank of India (IDBI) to, among other things, build infrastructure. It failed and even went bankrupt, with the government bailing it out recently. The government set up the Infrastructure Finance Corporation of India (IFCI). It also went bankrupt a few years ago without building any infrastructure and had to be bailed out with taxpayers’ money. Then there is the Infrastructure Development Finance Company of India (IDFC) which is still alive. It was set up by the government for exactly the same purpose as the recent company, with a mandate to fund infrastructure. Fortunately, IDFC is not yet bankrupt, mainly because it has made very few loans (its management is competent and realizes it cannot make more loans for the reasons highlighted in Nitin’s comments).

    Now we have the latest avatar of a failed policy. The only question is if the new infrastructure body will make lots of loans and go bankrupt or make few loans and stay solvent. The problem is not with lack of money but with stupid policies. Unfortunately, the point is not well-understood within India, except among the cyncial leaders who knowingly set up new companies to show that they are trying to do something while ignoring the real problem.

    Comment by Blue Sky — November 7, 2005 @ 8:41 pm

  9. You might have a point there Blue Sky.

    Comment by Vijay — November 7, 2005 @ 10:15 pm

  10. Well a country that is running around with high fiscal deficit will always have problem investing in infrastructure.And thats the case for India, subsidizes and low tax base eats up the tax revenue leaving little room for the state to invest in infrastructure.But setting up investment banks such as IDFC/IFCI is pretty meaningless as long a country has huge fiscal deficit,let alone red tape.

    Just as Amitabh points out that public investment stimulates private investment.It is this that fires up infrastructure projects in China.

    In my view it is better to bring down the fiscal deficit and expanding the tax base and then investing in infrastructure.

    Sandip
    http://www.skyscrapercity.com/forumdisplay.php?f=450 (India Skyscraper and infrastructure site)

    Comment by Sandip — November 8, 2005 @ 10:09 am

  11. How exactly would you do that Sandip? I think this is one case where I think we have to bet on a positive spiral.

    Most of the citizens of India are quite well to do. If people can afford to pay a crore for a one bedroom apartment as a symbol of prestige, yes I am sure they are doing quite well than even the corrupt politicians can.

    Unless we have a system that starts making people accountable nothing is going to begin and anything that begins is not going to end the way we plan it. My conviction, is what I am working on at the moment. An IT infrastructure that starts to put things in perspective. We need data to manage all this hoards of people and it is absolutely necessary to have information on people if we want to provide emergency relief and such.

    Less than 2% of the people pay their taxes. If we build a system that will make the people accountable and will make them pay their taxes, then the spiral begins. The more money we can get back, the more the government can invest, and the more employment, and the better the quality of life. Of course, there are a lot of economics involved, but I want to keep it simple for everybody to understand.

    Once we can build a basic framework to work with, it is much easier to build all the resource hogging projects like the transport system and so on. That’s definitely my thought.

    I think Sandip is wrong in the sense that he says that India doesn’t have the money. Two weeks ago, there was a report that all the provinces have an excess of approximately 150 crores and have no idea what to do with it. I was actually surprised that the politicians didn’t split it among themselves, but there’s the problem as well. We can gather resources, but spending them in a systematic way and doing it efficiently… well, where’s the system to begin with??

    Comment by Vijay — November 8, 2005 @ 10:41 am

  12. Vijay,
    thanks for your preply,

    im sorry if you misunderstood my post as the citizen dont have any money at all,that was not my intention at all.

    My aim with my post is that the tax base in India is way to narrow and more goods and services should be brought under the tax net. The first step was taken thanks to VAT that was introduced in april(?).

    As you point out in you post only 2% of the public pays income tax for several reasons,One reason is that the tax structure in India is very complex and tax institutions dont have a clear view of who pays the income tax or not. This also makes it easier for the citizen to ignore paying the tax.

    As the tax collection is now,Indirect taxes (etc customs)are bigger than direct taxes (income tax).When it actually should be the opposite.

    As you pointed out the question on how to solve it is to make taxation more simple.Of course this requires huge database of every tax paying citizen. The BPO industry in India has the technical and economical resources to tackle the organizational issues of making tax structure more simplified.

    It is a huge task and it is not simple,but i am confident India has the resources to tackle it.

    Some articles by Andy Mukherjee regarding the tax structure in India:
    http://www.iht.com/articles/2005/03/23/bloomberg/sxmuk.php
    http://www.iht.com/articles/2005/06/02/bloomberg/sxmuk.php
    http://www.iht.com/articles/2005/02/24/bloomberg/sxmuk.php

    regards
    Sandip

    Comment by Sandip — November 8, 2005 @ 7:52 pm

  13. Sandip,

    That was an excellent response and one that I was counting on. That is precisely what I am working with.

    I am dedicating some time off from my career to make some initiatives on that front. What’s deeply been troubling me is the fact that we claim to be the biggest pool of IT resources, yet we cant somehow build an IT infrastructure. I am working with the Indian Institute of Technology in coming up with an efficient system and implementation to build such a structure. Every citizen will have their unique identification number. And there will be databases that will govern the income/expense report of the businesses and will cross reference it against the citizenship database. I don’t think I’ll be able to do a fair job in trying to explain the whole system here, but I think there is a working solution.

    I am not sure what your background is, but if you are interested, get in touch and I’ll let you know what it is that we are planning. We as a nation, are in dire need of a framework to work with.

    Comment by Vijay — November 8, 2005 @ 11:26 pm

  14. Vijay,

    thanks for your reply.

    yes i would be interested if you can keep me updated about your field and the plans for the BPO industry.My knowledge of the BPO industry is very limited but if you can keep my updated of your project i would be more than happy.

    There is enormous opportunities for the indian BPO industry and IIT to make a field in state planning issues.

    As you pointed out there is a need for unique identification number for every citizen. In Sweden ,the identification number for example looks like this: Lets say you are born in 1975, first of august and gender is male,and you are born in Stockholm.

    the identification number comes out as : 19750801-5112

    more info about the system over here : http://en.wikipedia.org/wiki/Personal_identity_number_%28Sweden%29

    In India the number base would be bigger due to the size of population.But it will work.

    I live in Sweden and i am a NRI. My main field is design engineering and my other field is welfare state planning.I have always been ideologically devoted to the swedish economic model.

    i will send my e-mail to your blog so you can keep me updated about the project.

    regards
    Sandip

    Comment by Sandip — November 9, 2005 @ 7:26 am

  15. That’s very interesting about the swedish model. It says a lot when they have a 4 digit number as unique identification :) Yeah, I think in India it will be a bit bigger. I’ll definitely keep you posted Sandip. Thanks for the great feedback!

    Comment by Vijay — November 9, 2005 @ 10:33 am

  16. Response to Nitin:

    I completely agree that if the private sector is investing adequately, the govt. should leave it well alone. The projects I have in mind are
    - roads
    - power plants
    - large irrigation projects

    There is clearly not investment occuring in these. My view is we should not be held hostage by ideology. Let’s just find a way to invest – raising capitak-labor ratios is the best way to improve standards of living.

    Yes, I agree that if the govt. has to do it, it will need to cut subsidies or raise more resources.

    Comment by amitabh — November 10, 2005 @ 12:26 am

  17. hmm..

    I do think that there is a lot of private investment going into the Energy sector, be it Oil, or power plants. It’s mostly because it is a very profitable business and it is deemed as a basic necessity which everyone will pay for without raising any qualms about the price.

    But, I am not sure why any private sector would invest into Roadways. What’s the return of investment and how is it made? None of the private investors give a darn about the common good and the welfare of the public. They are all out there to make money and that’s the only motivation that drives them. I don’t blame them, revenue has been the biggest driving force for everything that has grown “successful” in this world.

    I have the same doubts when it comes to irrigation projects as well. Unless all the farmers decide to pay off a percentage of their production to the investors, there is very little reasons to pour money into it.

    It should be the government that should care about these things. There is very little reason why private investment sectors should find this interesting. Unless I am totally missing something here, in that case, do enlighten me.

    And oh, I am not sure how involved private sectors can get in respect to Roadways. We have a main road passing through our town and there were a few well-to-do people in town who wanted to clean it up, and maybe lay interlock tiles to make it look good. The government office didn’t allow that. Apparently its only the government that has right over maintaining and laying the roads. I personally thought there was too much bureaucracy in that. Just an example.

    As I said, If I am totally missing something here, do enlighten me.

    Comment by Vijay — November 10, 2005 @ 1:04 pm

  18. I thought India did have investment in roadways from the private sector. For starters, there was Unitech and L&T, both of which had a hand in either the NH2 or the NH8, leading to Chandigarh and Mumbai respectively. As far as ROI on roadway construction/investment is concerned, its not a very difficult model – let the developer collect all toll taxes for the next decade or so, after which, another tender can be placed for a private sector provider to maintain these roads. Thats how most freeways in the West are built and profitably run, besides being reasonably well-maintained.

    Comment by cow tse tung — December 14, 2005 @ 6:43 pm

  19. Cow Tse Tung:

    Generally roads and similar infrastructure in western and many other developed countries have been built by government or the public sector. Toll roads have become more fashionable of late since public funds (i.e. taxes) have become more scarce. I know this for a fact since I have worked for 9 years as a transportation engineer in the U.S. Private investments in roads would account for 5% or less of the total in the U.S. Toll roads are few and far in between and make economic sense on rare occasions (thus explaining why they are few and far in between). The reason is not difficult. Most people view roads as a “public good”, i.e. once it has been built it is hard to exclude non-payers from using it (kind of like a aircraft carrier for the Indian Navy for example – no one wants to pay for it because everyone in the country is entitled to its benefits regardless of whether they pay for it or not). Some basic microeconomics proves that private parties tend to be inefficient in “public good” markets.

    There is nothing wrong with public sector being allowed to develop roads. In a narrow sense the government is right to create these public sector investment vehicles. However, we all know that the best public sector services happen when they are held accountable for their performance. And this is where our government and the public sector agencies that build roads fail.

    regards,
    Murli

    P.S. BTW, excellent name (cow tse tung)

    Comment by Murli Adury — December 18, 2005 @ 5:54 am

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  21. In India incom tax is taken as a burdon but people have to understand for over all development of country it will be a life blood for economic development.

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