The Indian Economy Blog

October 19, 2006

Investment And Infrastructure In India

Filed under: Business,Infrastructure,Regulatory reforms — Edward @ 12:21 pm

Last week Cherian Thomas and Anand Krishnamoorthy had an article on Bloomberg where they suggested that lack of clear investment rules may impede the inflow of investment funds which could make possible the truly daunting programme of infrastructural works which are needed in India between now and 2010.

Indian Prime Minister Manmohan Singh may struggle to convince investors to help fund $320 billion of infrastructure spending by 2010 because he can’t persuade his government to draw up investment rules.

Singh, 74, doubled his budget for roads, railways and ports in New Delhi on Oct. 7, saying industry regulators are needed to spur investment and balance higher returns with low user charges. Railway Minister Lalu Prasad, who needs $66 billion to upgrade the world’s second-biggest rail network, rejected the plan.

Infrastructures are hugely strained:

Infrastructure utilities are strained. Highways, which move about 70 percent of the goods transported in India, account for only about 2 percent of the country’s 3.32 million kilometers (2.1 million miles) of roads. It takes an average 85 hours to unload and reload a ship at India’s major ports, 10 times longer than in Hong Kong or Singapore, according to government figures.

Regulators are needed, but there is no consensus on what kind of regulators India needs, or what objectives they should be pursuing:

Railway Minister Prasad opposed Prime Minister Singh’s idea of establishing a regulator for Asia’s oldest network, which moves 6.6 billion people a year. He contends only the government will be able to balance fares and returns on investments.

“We can’t have regulators as we have social obligations which only the government can deliver,” said Prasad, whose ministry employs 1.5 million people and has a separate budget. Indian Railways subsidizes passenger fares by charging freight customers more, losing half its share of the goods transport market to road operators in Asia’s fourth-biggest economy.

So resources are constrained, and competing objectives complicate the decision making process. In addition, as has been argued in the last post, fiscal excesses in India in recent years mean that the role of public funding in the infrastructure programme will inevitably be relatively limited:

Singh wants to spur investment by setting up public-private partnerships to build air, land and sea facilities. Attracting private capital can be successful if there is a policy framework regarding returns, tariffs and service quality, he said.

Public resources available for investment in infrastructure will be limited,” Singh said. “Our experience shows that public-private partnership is best suited for the infrastructure sector. The telecoms sector is a case in point.

Now given my continuing and profound ignorance about the details of how such matters work in India, I thought it might be useful to avail myself yet one more time of the more detailed knowledge of commenters Aninda, Nandan and Venkat, to find out just how they see the situation. You can read their main input in the comments below, here, for now, are some brief extracts:

Aninda

Increasing investments by such a large extent in such a short time with such little planning seems rather far fetched to me. The Bloomberg article discusses the regulatory impediments to public-private partnerships and these could be challenging, given the scope of the PMs stated objectives.

At current rates of 8% trend growth and a rising I/GDP ratio that goes from 28% today to 33% by 2010, with incremental capital deepening of 11 to 12% per year, the $160Bln of additional capital –the base case- is easily attained, with a sustained incremental-capital-to-output-ratio (ICOR) of just over 2.

However, when you get to doubling the required investment outlay, to prompt the economy to grow at 10% between now and 2010, the incremental capital deepening doubles per year, and the ICOR deteriorates sharply by 40% to 1.3.
(continued below)
Venkat

The size of the infrastructure investment needed for india is enormous : USD 150 bn – USD 300 bn – USD 500 bn. The numbers are in 3 digit + USD bn, and this is significantly more than the total investment in the country : personal + corporate + infrastructure + government! This is nothing new.

Yes the country has made some progress

a) Indian telecom : Is the usual poster boy. The kickstart to this sector came thru the introduction of new technology : mobile telephony, which customers liked. This led to competition – different players (indian – foreign – telecom cos – financial investors) wanted a share of the pie hence new technologies and new areas were exposed. To ensure that it was not chaos allround – the regulator had perforce to step in and we now have a sector which is about 100 mn mobile connections + about 50 mn fixed line connections + 2 mn broad band. All this while, I think Indian telecom : voice – mobile – leased line for data would be amongst the cheapest in the world. Quality wise it is slowly improving. (continued below)

Nandan

Manmohan Singh? He is a reformer and an economic progressive; but I fear he might be too irretrievably attached to the old order to have a substantial impact on the future. What about Narayan Murthy and the Infosys guys? Perhaps; they would probably get the most NRI votes. But, tellingly, that might be because their biggest customers are abroad. In my view, the honor belongs to Dr. E. Shreedharan, the chief architect of the Delhi Metro. (continued below)

Edward Again

Just one final point, since I am in no position to make a substantial contribution to this debate: the global implications (since the global economy is something which I do, to some extent, know about). The numbers that are being talked about here are enormous, and an inflow of funds into India on this sort of scale would have important consequences across the global economy. Now, assuming, as I am inclined to, that China more or less maintains the present head of steam up to the 2008 Olympics, and imagining that what is being talked about here really starts to happen, then this may well place a lower platform *under* next years global slowdown. In other words we may well see a soft landing in the global context (so eat your heart out on the US housing “crash” Nouriel Roubini for one), but if we do then it will be for quite different reasons from the ones which most commentators have been suggesting would be the case. In general the expectation was that the German and Japanese economies would take the strain on global growth as the US and China slowed. This is not happening, and the Japanese and German economies both seem to be slowing in their turn. But what we may well have in front of us is a situation where infrastructural (and possibly in the case of China, consumer) demand in the two newly developing global giants generates the momentum and velocity needed to help the rest of the globe avoid driving straight into the proverbial brick wall. This is truly new, and very exciting.

8 Comments »

  1. ncreasing investments by such a large extent in such a short time with such little planning seems rather far fetched to me. The Bloomberg article discusses the regulatory impediments to public-private partnerships and these could be challenging, given the scope of the PMs stated objectives.

    At current rates of 8% trend growth and a rising I/GDP ratio that goes from 28% today to 33% by 2010, with incremental capital deepening of 11 to 12% per year, the $160Bln of additional capital –the base case- is easily attained, with a sustained incremental-capital-to-output-ratio (ICOR) of just over 2.

    However, when you get to doubling the required investment outlay, to prompt the economy to grow at 10% between now and 2010, the incremental capital deepening doubles per year, and the ICOR deteriorates sharply by 40% to 1.3.

    Leaving aside regulatory issues for the moment, the drop in ICOR is unavoidable unless economic growth can be substantially higher than 10%. Consequently, and leaving regulatory concerns aside, the implied drop in “Return on Equity” (RoE) alone would make anyone think twice about the attractiveness of such investments. And if the government keeps promising tax breaks/exemptions to attract the hard capital, it would in effect amount to a fiscal subsidy of indeterminate amounts. If such fiscal deals do indeed fall under PP partnerships, then they could even be kept off the books till such time the underlying projects come on-stream.

    All said, the country’s institutional structures, capital markets, and possibly even the environment is simply ill-equipped to deal with the complications that may accompany such large investment projects. India still has rather shallow pvt sector capital markets, delays in contract enforcement, foreclosures, little or no concept of large-scale asset securitization. And frankly, places like Bombay and Bangalore have no concept of urban planning, or even effective zoning. Consequently, simply throwing billions of dollars at them ain’t gonna suddenly make them grow like Shanghai or even Dubai.

    Aninda

    Comment by Aninda — October 19, 2006 @ 12:25 pm

  2. The size of the infrastructure investment needed for india is enormous : USD 150 bn – USD 300 bn – USD 500 bn. The numbers are in 3 digit + USD bn, and this is significantly more than the total investment in the country : personal + corporate + infrastructure + government! This is nothing new

    Yes the country has made some progress

    a) Indian telecom : Is the usual poster boy. The kickstart to this sector came thru the introduction of new technology : mobile telephony, which customers liked. This led to competition – different players (indian – foreign – telecom cos – financial investors) wanted a share of the pie hence new technologies and new areas were exposed. To ensure that it was not chaos allround – the regulator had perforce to step in and we now have a sector which is about 100 mn mobile connections + about 50 mn fixed line connections + 2 mn broad band. All this while, I think Indian telecom : voice – mobile – leased line for data would be amongst the cheapest in the world. Quality wise it is slowly improving

    Or it is a combination of new technology/ unfulfilled demand/ competition which were contributing factors to the growth of this infrastructure

    b) Ports – especially containers ports is the next poster boy. This was kickstarted by privatising the 2nd container terminal in bombay. ie. the hinterland where the demand exists, the evacuation facilities for moving containers in and out to the actual sites, deep enough waterway, trained logistics people ; all already existed in bombay. the demand as usual focussed on a ‘ new aspect’ – container freight in India in early 2000. This aspect of freight was less than 10% of even bombay port, leave alone all India freight loadings. The convenience and the increasing demand for international trade – in & out of India, made this demand grow at 20% + levels while regular freight was at 8% levels. Or there was a clear demand gap which could not be met. This was sensed by port major P&O, and the equipment/ processes were kept keeping the larger picture in mind, not just bombay alone. Mother vessels started landed, and now in a short span of about 8 years, the container traffic at bombay has overtaken colombo, where the loads used to go for transhipment
    The bombay port ideas was soon taken up at many other ports – madras, mundra, cochin, vishakapatnam, calcutta. and hence there has been a significant increase in container traffic, which is now almost at 15% levels of all india traffic ! all in about 8 to 10 years

    the key driver – new technology/ segmentation. regulators have not really played any leading edge role in this sector, other than keeping unhealthy competition out – IMO

    c) roads

    this was kickstarted by the previous government doing some pump-priming in 2002 or so, and offering govt-guarantees for making upthe short-falls in toll collections. IMO there has been no significant new technology used (to say control costs of construction/ maintenance) or new routes which have opened new loads/ destinations. Or this was a sector which has received attention because of the allocations/ financial engineering. Maybe the financial engineering aspect is the contribution of the regulators/ bankers

    however – key aspects like better policing to prevent overloading, or landbanking to improve project viability and harness greater number of implementers in a transparent manner (rather than the opaque manner today) has not really been done. or new ways to minimise the delays of goods when they cross/ enter state/ city borders. neither has this sector received any fresh thinking on handling problems of urban transit

    hence the perception of many users would be that there is progress – it is patchy – no real progress made in terms of capacity or quality or usage patters. i cant really think of even who is the regulator here !

    d) power

    the less said about it the better – a lot of muddling is going by the usual suspects. Corporate sector puts up its own plants, generally to the extent of 100% if it can afford to raise the capital! Government does only what it can invest. No fresh investment has really come in, of any significant manner. The only new thing that has happened in the last 10 years , is rather than deteriorating the situation has been held steady. one factor could be the development of power grid networks – state level to regional then to interregional and now to even get power from nepal/ bhutan etc. this has significantly improved the grid discipline, and the number of major power outages has reduced – though the basic gap between supply & demand has not come down! the previous efforts at guaranteeing returns to projects like Enron’s Dabhol came seriously unstuck with the next government overturning all the agreements !

    now ofcourse they have comeup with this new concept of Ultra Mega Power projects – where all the developmental aspects (Power Purchase agreements, fuel linkages, land, environmental clearances etc) would all be completed and then be bidded out. 4 such projects, total capacity 16,000 MWs (or about 12% of current installed capacity) are already announced for bids in December 2006. it remains to be seen whether this round will be any better in attracting fresh investment into generation

    there have been regulators in all the states who are supposed to decide on the tariffs. but the political parties have not allowed these people to function in many states (delhi/ maharashtra come immediately to my mind). this was part of the unbundling of the sector (into generatin- transmission- distribution), i think prescribed by worldbank for granting loans

    i may be quite pessimistic, but the key problem is the commercial & technical losses which amount to over 35% in many states. or the billing is only for 65 units of every 100 units supplied ! unless there is some technology eg. prepaid power meters/ policing to ensure that free supplies are not there. this sector cannot change to function in a manner where market rules apply

    or the key innovation needed is how to get the political parties to support that power should be paid, and is not a largesse ! the other aspects of fuel/ uptime – grid management – rapid project implementation have already been addressed. this where i guess the democratic aspect of india is hindering the development of this sector and hence the innovation has to come from the politicians/ administrators side/. I cant see the supply side having the credibility to tackle this problem

    f) railways

    here i think there has been a significant turnaroiund in the financial aspects of this sector in the last few years. it is now expected to generate a surplus of about USD 4 bn up from an operating surplus of a few hundred million 5 years ago. the key factor – policies which generate traffic/ utilise spare capacities. key driver – the politician railway minister

    from the above you can see different experiences of sector development – with and without regulators

    envenkat

    Comment by Venkat — October 19, 2006 @ 12:29 pm

  3. Which Indian today best represents the modern India?

    Manmohan Singh? He is a reformer and an economic progressive; but I fear he might be too irretrievably attached to the old order to have a substantial impact on the future. What about Narayan Murthy and the Infosys guys? Perhaps; they would probably get the most NRI votes. But, tellingly, that might be because their biggest customers are abroad. In my view, the honor belongs to Dr. E. Shreedharan, the chief architect of the Delhi Metro.

    The project kicked off about 7.5 years ago, and the first and largest phase, which covers the main city areas (phases 2 and 3 are to link to the suburbs/satellite cities), is about 97% complete. The first leg of the train went operational in 2002 (a year ahead of schedule), and four years later, Delhi boasts arguably the finest public transport system in South Asia. More importantly, the project came in under budget (total projected cost: $2.35B), and that allowed the private management company (DMRC) to hold down passenger fares. Worries that the cost of the project would make tolls prohibitively expensive for the masses were proved wrong, and today, the trains operate with standing room only, the stations are not irritatingly crowded, and trains are frequent and prompt. In 2005, the Metro carried 1.5 million passengers per day (expected to increase to 2.6m by 2011). Compare that to the 4.8m daily riders of the New York subway (a city with comparable population) which has 16 times the track length and was started more than 100 years ago.

    It is tricky to extrapolate from success in one area (in this case, transportation) in order to draw lessons for another (say, power). Nevertheless, it is instructive to examine the unmitigated success of this project in order to see how to efficiently implement large-scale infrastructure projects amid India’s frustrating bureaucracy. So what are the big lessons of the Delhi Metro?

    (1) It is not enough for the government to simply ‘get out of the way’ – it must also act as the primary enabler. A mass transit system for Delhi had been on the drawing board since the 1970s, but the plan moved from desk to desk and was unable to find a person with the courage to implement it. While Delhi-ites languished in traffic jams during the intervening years, the plan was developed in some important ways – the track layout, the phased implementation, the decision to go with electric rather than mag-lev trains were all planned by commissions set up by the Railways Ministry.

    The government was also fairly creative in setting up a financing structure – the project was financed by equity contributions from the GoI and the Delhi Government (15%, or $200m, each), a soft loan from the OECF-Japan (~56%), property development revenue (~6%) and other subordinated debt (~8%). The loans are to be repaid through ticket and property development revenue, and taxes levied by the Delhi government. This structure adequately filled the capital requirements, and, through the terms of the debt, imposed a good degree of management discipline.

    This highlights an important fact: the private participation model which the government seems intent on promoting is still a distant dream. Even if the projects become financially viable, it is extremely unlikely that the large majority of these will be able to offer returns that will whet private investors’ appetites. In the mean time, it is necessary to develop a viable market for municipal bonds in order to bring in some much-needed liquidity into the sector. Presently, our domestic private debt markets are practically non-existent (demonstrated by the fact that DMRC borrowed primarily from Japan).

    (2) Infrastructure can (and should) only develop where there is sufficient demand for it. When looking at levels of infrastructure investment, analysts perpetually compare India with China – usually without acknowledging that the models are completely different. A lot of the infrastructure investment in China has been pre-planned and not market-led. Because of the loose (and in my view, imprudent) monetary and foreign exchange policy of the Chinese government, the inflation-adjusted cost of capital for infrastructure is virtually zero. This allows them to build pretty much anything they want, anywhere they want. In some places (like Shanghai, or along the coast), the demand develops once the projects come on-stream. Other more-poorly thought out projects, presumably, are not so lucky.

    This is a luxury that India can not afford. Poorly-planned projects will not only show up as non-descript NPLs the way they do in China. Instead, they will show up directly on the fiscal ledger—thus imposing a direct cost on our taxpayers. Part of the reason that infrastructure has been slow to develop is that 2% growth does not demand the kind of infrastructure that 8% growth does. Now that we are apparently on a higher growth trajectory, we can see bits and pieces of evidence that infrastructure construction is responding in kind. If the government can get the institutional framework roughly right, then we should see infrastructure investment grow (at least) in line with GDP. This will probably not be enough to make Mumbai resemble Hong Kong or Singapore, but it will help fulfill the needs of our manufacturing, services, and agricultural industries.

    (3) The best panacea for the ‘infrastructure deficit’ is good management – not changes in regulation. Though regulatory changes are clearly needed, the most important lesson from Delhi Metro story is that good management is the only way to balance the political and economic imperatives of infrastructure. Dr. Shreedharan was effective precisely because he knew how to balance the government’s desire for low user fees with the need to make the project financially viable.

    Furthermore, rather than just bemoaning the bureaucratic red tape, he looked for creative workarounds. He understood that because he was backed by public money and was constructing a (quasi-) public good, red tape was unavoidable. He managed to take a private sector management approach in terms of financial discipline, deadlines, etc. while fully appreciating the public sector’s sensitivity.
    If world-class infrastructure is to become a reality in India, we need a lot more Shreedharans. As Aninda and Venkat both pointed out, private investment will not be sufficient to meet the vast needs. The government will need to take the lead without losing its fiscal shirt in the process, and managers with a private sector orientation will need to step in and act as the implementers of the government’s plans. Because Dr. Shreedharan saw this far ahead of time, and because of my belief that this is the best way forward, I consider him the exemplar of the modern Indian economy.

    Comment by Nandan Desai — October 19, 2006 @ 12:33 pm

  4. Nandan,

    A very good piece on EA Sreedharan and the Delhi Metro.

    Mr Sreedharan is also the same the person responsible for the Konkan Railway project, which is the single largest rail network addition to IR, post independance. It was also done on time and on budget. If I am not mistaken, he had retired, and he was persuaded to take up the Delhi Metro assignment despite his age on the administrative records !EA Sreedharan is also a very good example of what a bureacrat can do in the marketplace, and the difference in approach they bring about

    Montek Ahluwalia is another face of emerging India – which is now trying to bridge the market-place and the political space. Some other names which also come to my mind are the ex BHEL Chairman – Krishanmurthy, MUL CEOs – RC Bhargava (ex-CEO) and Jagdish Khattar (current), who have run businesses in markets open to global competition, and still retained their ‘public’ character. I wish there were more such examples from the current crop of bureacrats ( eg. I cannot think of anybody like Swaminathan in the 60s, looking at the issue of technology in the agricultural sector, or a KL Rao who did a lot of original thinking on irrigation and floodmanagement, or who ever was the ‘guiding person’ behind the setting up of IITs/ IIMs/ Centers of Excellence)

    We do need a stepup in the motivation and caliber of our bureacracy to be able to integrate the society. Currently the Govt/ politicians/ bureacracy all seem to not mind the courts do all the interpretation of decisions!!!

    I do agree with your view that EA Sreedharans are an important face of the emerging india

    EN Venkat

    Comment by Envenkat — October 19, 2006 @ 12:35 pm

  5. India set to overtake China says a report

    New Delhi: India, now in a ‘sweet spot’ economically, is set to move on to double digit growth despite politics and populism and may be ahead of China’s growth by 2010.
    “The hype about India is real. Factors are in place to sustain 10 per cent plus growth. Investment at over 40 per cent of GDP this year is one of fastest jumps in history,” renowned economist Surjit Bhalla said in his mid-term review of the economy.
    The mid-term review showed that India was poised to achieve a high level of growth as savings and investment rates were steadily rising.
    The steady increase in savings and investment to 40 per cent and an additional 3 to 4 per extra growth from extra investment would result in a 10 per cent GDP growth.
    Bhalla also felt the exchange rate should be kept undervalued to make India more competitive in the global market.
    He said for the last three-years, the growth in manufacturing had been greater than 10 per cent and overall industrial growth has been over 9 per cent and sustained progress in these sectors could push the GDP growth further.
    Bhalla said that India had a 5 to 10 year lag when compared with China. But while comparing the two countries it’s forgotten that China is at an income level and middle class level that is almost twice that of India. But the level of poverty in the two countries is almost the same, Bhalla said.
    Though the poverty level in India is put at 22 per cent of the population, it in fact must be much less at five per cent if correctives were carried out in the methodology of the calculation.
    When the correctives are applied, the poverty level at five per cent would be on par with that of China. The methodology adopted in India presently was based on average survey of consumption expenditure of people. But consumption expenditure in India does not take into account 55 per cent of national accounts consumption, he said, adding that the present methodology grossly overestimates poverty level.
    Inequality has also been steady for 25 years after declining between year 1950 to 1983 and employment growth stands at 2.5 per cent per annum, he said.

    Comment by Parelkar — November 6, 2006 @ 9:33 pm

  6. [...] Curiously though what Surjit is saying does rather fit in with what we talked about on this post here (which examined the state of play as far as potential for infrastructure investment in India goes). [...]

    Pingback by The Indian Economy Blog » Sizzling, Or Just Right? — November 29, 2006 @ 11:19 pm

  7. thanks for posting stuff that is highly relevant and education. I do not have an economics background and at this point trying to learn it. Altogether a wonderful post.

    I totally agree with Venkats comments that

    “We do need a stepup in the motivation and caliber of our bureacracy to be able to integrate the society. Currently the Govt/ politicians/ bureacracy all seem to not mind the courts do all the interpretation of decisions!!! ”

    In addition I think a lot more is needed in terms of our attitude as society. It almost seems that the number of people with a real stake in the scheme of things is very low compared to the population. The taxpayer base is very small and the whole nation lives on this population. Only this population has any stake in how things are happening and obviously they are a minority.

    This needs to be increased by improving the taxpayer base. In addition this will leave the public exchequer with more funds that can be spent on infrastructure. With more people having a stake in the process, there will be more oversight and more sensitization of the bureaucrats towards the need of the society. Currently the burden of performance is with the bureaucrat. If he is good,sincere and motivated things happen. Otherwise nothing happens, there is very little oversight.

    I think to a certain extent RTI act will help towards improving the current situation. I have a lot of hope.

    Comment by Vinod — December 7, 2006 @ 12:46 am

  8. investment needed over next 5 year is 1000 billion dollars. from where this money will come. I have an idea indian government should issue 7 % tax free bonds of 1000 billion dollars or more.Repayment and interest payment of these bonds should be done as services provided by respective infrastructural activity. 200 billion dollars can easily be invested in railway to make it more efficient. Repayment of railway bonda can be done in form of any service provided by it Total revanue of railway can be 400 to 500 billion dollars over next 10 years. telecommunication revanue can be 800 to 1000 billion dollars over next 10 years. Am i wrong.

    Comment by alok sharma — March 2, 2009 @ 10:42 am

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