Infrastructure: Castles in the air? - Views on News from Equitymaster

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Infrastructure: Castles in the air?

Jun 15, 2007

The government of India aspires to accelerate the GDP growth rate to 10% by 2012 - a rate not very distant to that achieved by Japan and some other East Asian nations during their growth phase in the second half of the twentieth century, and one that China has achieved over the past two decades and continues to deliver.

Real GDP growth during peak periods
Average annual growth rates%
India (1990 - 2000)5.7
Malaysia (1960 - 1995)6.9
India (2000 - 2006)6.9
Thailand (1960 - 1995)7.5
Hong Kong (1960-1995)7.7
Japan (1960 - 1980)8.0
South Korea (1960-1995)8.1
Singapore (1960 - 1995)8.4
Taiwan (1960 - 1995)8.6
Source: IDFC annual report

It is heartening to note that all stakeholders seriously recognise the central role that infrastructure development will have to play in helping sustain the economic growth - at an annual 8% plus momentum achieved during the last few years. Clearly, the US$ 320 bn (Source: Committee on Infrastructure, Government of India) investment in infrastructure (adjacent chart shows the broad breakup) estimated to be required during the Eleventh Plan period (2007-2012) is a mammoth task to accomplish. Public investment, given governmental priorities to rein in the fiscal deficit and increase spending in the social sector, has to necessarily be supplemented by public-private partnerships (PPPs) and in many cases exclusive investment by the private sector.

Regulatory Issues
In order to reap the benefits of enhanced private capital investment and the anticipated efficiencies in project execution and operations, the regulatory regime must ensure both a fair economic return and transparency in the bidding process.

Financing Issues
The year 2007 could mark the culmination of several innovations in financing models and the creation of alternative sources of capital required for financing infrastructure development. Infrastructure projects continue to rely heavily on debt financing (mainly from banks) and to a lesser extent, on sponsor equity. In many cases, a debt to equity ratio as high as 4:1 is seen. Excessive leverage can be harmful, particularly when the economic cycle turns and revenue forecasts under-achieve during the concession period in what are essentially long-term infrastructure assets. This can place a strain on debt servicing, and a few bad loans can discourage future lending to the sector. While banks have begun extending loans with tenors beyond 12 to 15 years, projects could be saddled with refinancing risks while exposing the banks to potential asset-liability mismatches. To overcome this risk, in the short term at least, some banks prefer tie-ups with large institutional investors to create a form of joint or 'take-out' financing.

Possible milestones...
A number of interesting developments are expected to gain rapid prevalence this year, and have the potential to supplement infrastructure financing. Firstly, the Government of India has put forward a proposal to leverage India's huge foreign exchange reserves (currently estimated at over US$ 208 bn) to fund infrastructure projects. The notion of funding infrastructure assets from income generated by investing a portion of foreign exchange reserves in higher-yielding assets is a welcome step and needs to be pursued to its logical conclusion.

Second, the Ministry of Finance has proposed a dedicated US$ 5 bn infrastructure fund with in partnership of IDFC, Blackstone group and Citigroup private equity investors. If more such funds come to fruition, it could open the doors for substantial equity fund flows into the sector.

Further, to distribute the risks more equitably across the financial system, the market needs new instruments such as securitisation to develop rapidly and in a sound manner. Finally, we need to address the challenge of governance. Most of us are aware that India's reform options are constrained by the coalition politics and complex decision making process, which is estimated to cost us as much as 2% a year in GDP growth (source: S&P report). Governance is a fundamental theme that cuts across all aspects and segments of the infrastructure development challenge. It encompasses inter-government departmental issues, Centre-State tension, rural-urban divide and public-private competition.

To conclude...
As India's economic growth picks up momentum and the country aspires to achieve 'developed economy' status, the need for addressing the deficiencies in infrastructure sectors to sustain high growth in future has become stronger than ever before. There is also a growing consensus that improvement in infrastructure can have strong impact on poverty alleviation, helping India better achieve its millennium development goals. Against this backdrop, the government needs to show commitment in accelerating infrastructure development as indicated by its recent resolve to significantly raise infrastructure spending in the next five years. Unless otherwise, we shall only be building 'castles in the air'!


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