Monday, January 5, 2015

India's new paradigm in financing infrastructure and attracting investments

India's Twelfth Five Year Plan estimates a trillion dollars investments in infrastructure. But a trifecta of problems threaten to pour cold water on these ambitions.

One, governments, both at the center and in states, are fiscally strapped and are likely to remain so even after recovery takes firm hold. Two, debt-laden infrastructure firms, especially in power and transport, have little or no space within their balance sheets to take on newer projects. In any case, despite all the hype around PPPs, many of these projects are hugely risky and are not amenable to such financing. Third, banks, especially the public sector ones who make up nearly 80% of the lending, are struggling with double-digit impaired assets and are touching their sectoral exposure limits. Even with the most aggressive reforms, the situation is unlikely to change in the foreseeable future. 

Faced with this perfect storm, governments appear to believe that the way out is by collaborating with foreign governments. More specifically, in partnerships with East Asian governments, whose large investible foreign exchange reserves are currently invested in low-yielding US Treasury bonds. In the face of global economic weakness and ultra-low interest rates in developed economies, these countries have limited investment options. In their search for yield, the sovereign wealth funds and external lending agencies of countries like China, Japan, and Singapore have been scouting higher-return long-term investment opportunities across the world. The size of India's economy and its relative strength makes the country an attractive investment destination. 

Realizing this, a few state governments and the central government have been aggressively wooing these governments. The successful summit meetings of the Indian Prime Minister with counterparts from Japan and China have provided a fillip to these explorations. Investments in infrastructure and manufacturing, both public and private, are being pursued on the back of bilateral agreements between governments. Such investments come essentially in two forms - long tenor concessional loans to finance infrastructure projects and financing of large industrial parks through joint ventures between public and private entities of the two countries. 

An MoU between the governments of India and Japan commits Japanese capital to the development of a 1500 km dedicated freight corridor between Delhi and Mumbai. Similar partnerships are being explored with Japan to finance a 534 km high-speed rail link between Ahmedabad and Mumbai at a cost of Rs 54000 Cr and with China for a 1700 km Chennai-Delhi link that would cut travel time from 28 hours to just six. MoUs have also been signed with the Chinese government to dovetail funding from China Development Bank for two large industrial Special Economic Zones (SEZs) in Maharashtra and Gujarat. The Indian and US Governments have signed an MoU to develop three smart cities at Ajmer, Allahabad, and Visakhapatnam. The government of Andhra Pradesh have signed an MoU with the Singapore government to develop the nucleus of the recently formed state's new capital city near Vijayawada. Similar MoU is being planned with Japanese government to develop the Vizag Chennai industrial corridor and facilitate Japanese companies to invest there.  

Such government-to-government partnerships have the potential to herald a new paradigm in attracting investments. However, they come with several cautions. 

1. Whatever the spin given, such investments in infrastructure are essentially public borrowings to be repaid over a long duration by government entities at different levels. Therefore, given the limited fiscal space, we need to be cautious not only about the scale of debts assumed but also about its public utility. In particular, instead of frittering away scarce money on grandiose aspirational projects with disproportionately low socio-economic utility, we need to channel it to financing projects which carry the greatest bang for the buck. This assumes greater significance since the counterpart governments are more likely to be interested in precisely such grandiose projects - like high-speed rail or metros - which offer the potential of highly attractive returns for their contractor and supplier firms. 

2. Another concern arises from the procurement conditions attached with such lending and investments. For example, lenders invariably insist that the contract be awarded to and procurements made from their firms. This raises concerns about whether public resources are being spent in the most cost-effective manner and on the most efficient technologies and appropriate systems. Even with the potential for joint ventures, Indian firms are likely to lose out to the larger and better endowed counterparts from these countries. Further, as experience of similar partnerships for real-estate based developments between state governments like Andhra Pradesh and Kerala with Middle Eastern governments have shown, the potential for cronyism and corruption are never far away.   

3. The Chinese, in particular, see development of SEZs in partnership with Indian agencies - MIDC in Maharashtra and DMIC in Gujarat - as excellent platforms for facilitating Chinese companies to invest in India without the general hassles associated with investing in the country. It could help orderly flow of production factors from China to India and an enabling regulatory framework that are required to support such investments. 

But given that Chinese imports are already out-competing Indian manufacturing, once these units become operational, the additional incentives that come with SEZs are unlikely to go down well with Indian manufacturers. In any case, there are enough doubts about the wisdom of encouraging manufacturing growth through the SEZ route

4. There are also concerns about the dynamics associated with Chinese investments which are certain to generate controversies and disputes. Howard French has written about the controversies surrounding Chinese investments in Africa on the displacement of local labor by Chinese migrants, racially clouded interactions with locals, and crowding out of local entrepreneurs and businesses. The visa problems faced by Chinese boiler-turbine-generator makers for Indian power plants and spying charges against Chinese telecoms equipment makers are cases in point.   

5. Finally, there are all the other risks and limitations associated with such capital inflows. Since these loans are foreign currency denominated and unhedged and the investments generate rupee cash flow, they leave the Indian government counter-parties exposed to foreign exchange risks. There is also a limit to such investments - a handful of iconic infrastructure projects and SEZs that are likely to materialize through this route can at best scratch the surface of requirements. 

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