Monday, July 28, 2008

Problems in financing urban infrastructure

This post will examine why infrastructure sector is not a homogenous group, and what are the reasons why private investments are easier attract in certain sectors than others. It is also a reiteration of the need for developers to have access to capital at the lowest costs, given the risks inherent in the nascent stages of development of some of these sectors.

Infrastructure financing has moved a long distance over the past couple of decades. Till the eighties, Governments used to finance all infrastructure expenditure in India. The nineties saw the emergence of private sector as possible investors in infrastructure sector. Private investments in infrastructure took off initially with the telecommunications sector and the roads being developed under the Golden Quadrilateral, and has now gained momentum with the interest shown by private developers in the development of projects in ports, airports and power generation.

The telecommunications sector was the first success story in the privatization of infrastructure. The entry of private sector ushered in a spectacular spurt in investments in network and capacity expansion, and the intense competition arising from multiple licence holders in circles led to steep declines in telephone tariffs. In India, given its low penetration, telecom service was not seen as a basic public utility, thereby evoking less opposition on its privatization. The culture and habit of user charges and cost revovery was already established in the telecom service market.

The spectacular economic growth of recent decades and the attendant spurt in internal mobility within the country, and more importantly commercial traffic, have provided a major filip to road infrastructure projects. Though, I do not have figures offhand, it will not at all be surprising if the critical revenue streams for most of the interstate highways bidded out under BOT by the NHAI, come from commercial vehicle traffic.

In fact, the biggest successes in BOT road projects have all been in major freight corridors. Private operators view the substantial and rising toll revenue streams as adequate and robust enough to finance road projects profitably, thereby minimizing their commercial risks. Again, the relatively upstream nature of the sector (being highways and not regular internal or link roads) and the consequent limited public interface ensures that there are a few of the other commercial and political risks associated with investments in infrastructure.

Sectors like ports, airports, and power generation, all of which involve single location activities, are inherently suited for private management. The private sector, with its operational flexibilty and incentive driven structure, is much better suited to operating and maintaining these facilities more efficiently. Further, the fact that these sectors are at the upstream end of the service supply chain (except maybe airports), means that commercial and financial viability by collection of user charges and cost recovery are not a major risk. Even in airports, the economic profile of the users ensures that commercial viability risk is minimal.

But water, sewerage, solid waste, electricity distribution and public transport services are still heavily subsidised across the country. Further, these services are widely percieved as basic public services, being accessed by everyone, rich and poor, and therefore to be delivered at affordable prices. There are therefore considerable commercial risks and financial viability issues associated with investments in these services. Further, in all these sectors, the private partner will invariably have to utilize existing assets.

All these are potential sources of political opposition. The only way private participation can be introduced in these utilities is by projecting the choice of better quality services at cheaper or only slightly higher prices. Conventional explanations like infusion of superior technology or efficiency impovements may not cut much ice, if they involve higher user charges/tariffs.

Given these problems and the substantial risks associated with them, it is important that private sector participants are incentivized by being able to access capital at the lowest cost. This is all the more important for those few sectors where private investments are still only marginal, posing as they are, considerable risks to the investors.

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