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Reform in the public sector

In search of new options

by Meine Pieter van Dijk
Dairy farmers on a train in Gujarat.

Dairy farmers on a train in Gujarat.

One of India’s greatest challenges is to boost infrastructure in spite of strapped public finances and generally rather poor state capacities. One option is to mobilise private-sector capital and expertise; and setting up new government bodies for doing so can prove useful. Different Indian state governments are pursuing different strategies. [ By Meine Pieter van Dijk ]

India is more integrated in the world economy than ever before. Exports are booming and Indian companies are becoming multinational giants. Fast economic growth, however, is putting a heavy burden on India’s infrastructure. The country needs new options for financing such investments. Currently only 40 % of Indian villages have electricity, often only for a few hours a day. Urban challenges include clogged roads, dismal airports and inefficient ports. Poor infrastructure, most experts agree, is one of the bottlenecks that are still holding the economy back.

According to the Government of India’s current five-year plan, infrastructure spending will amount to $ 492 billion until 2012. Most of the money is to be spent on power generation ($ 150 billion), roads and bridges ($ 76 billion). The rest is earmarked for telecommunication, sanitation, irrigation and railways. On top of these sums, however, the government expects twice as much money from the private sector.

Ashwani Kumar, India’s minister for commerce and industry, recently declared: “I envisage the total investments in industrial programmes and social and physical infrastructure projects in India by 2017 coming to about $ 1,500 billion, with the bulk coming from the private sector” (Financial Times, 22-5-2008). No doubt, foreign funding and participation may play a useful role. There is, indeed, interest in infrastructure projects (see box below), but in view of underdeveloped local debt markets and an unreliable regulatory and political context, it will be a daunting challenge to raise billions of dollars.

In many Indian states, however, the lack of project-preparation capacity is the real issue. It will be very difficult to attract private-sector funds and international capital, unless good projects are planned. Cost recovery must, at very least, seem probable. So far, the typical Indian bureaucracy does not perform well enough to convince international investors.


State-level financial institutions

Issuing bonds is an option for financing infrastructure. Major Indian cities do so. In principle, all local-government bodies in India could eventually be linked up to capital markets. For that to happen, however, they would have to improve their financial management systems dramatically. However, it may not be efficient for municipalities to issue bonds individually. It would probably be better to let some organisation raise the money, and then pass it on as loans for infrastructure projects.

Currently, state-level financial institutions (SLFIs) serve that purpose in some Indian states. Tamil Nadu and Karnataka are two states that have established SLFIs. The government sector in India is typically bureaucratic, and shows little concern for public finance. Often politicians influence decisions. Moreover, authorities tend to be too cash-strapped to afford the financial experts they would need. An SLFI has the advantage of operating at arm’s length from the government, and is thus more credit-worthy. Furthermore, SLFIs normally command adequate expertise. After all, it would make no sense to set up an SLFI without such skills.


Gujarati bottlenecks

The State of Gujarat, at present, does not have any intermediary institution that might issue bonds on behalf of local governments and then pass loans on to them. It turns out, however, that infrastructure development in Gujarat is hindered by limited municipal project-planning capacities, rather than by limited fund availability.

The Gujarat Infrastructure Development Board is the state institution to facilitate investments in advanced infrastructure such as ports, electricity and major roads. It is a high-level nodal agency, reporting directly to the state’s chief minister. However, it is not necessarily cooperating well with local governments.

The state government’s hopes for private-sector investments in infrastructure, moreover, were thwarted by restrictive municipal laws. They need to be amended to facilitate more private-sector participation. Finally, contract documentation is too poor to draft project plans in cooperation with private-sector companies.

On the other hand, Gujarat’s biggest city, Ahmedabad, has gained experience with obtaining a credit rating and issuing bonds to finance water and sanitation projects. Several toll roads were built with the help of the private sector; and, in principle, private financial institutions are eager to get more involved in infrastructure. Gujarat is one of India’s fast-growth states, and is known for a keen sense of entrepreneurship. That is also evident in the number of private consultants and specialised non-governmental organisations active in the field of infrastructure.

The state government has prepared and launched an Infrastructure 2000 Plan, which gives a vision and a strategy. It has also prepared a note on regulatory framework for water. The state was the first one in the country to draft a build-operate-transfer (BOT) law, and has experience with giving concessions to the private sector.

Nonetheless, such activities remain below potential. Gujarat would benefit from beefing up its regulations and institutions. Urban projects are indeed best suited for private-sector funding and planning. The state could learn from the Project Development Corporation of Rajasthan (PDCOR), which is a relatively small outfit in the neighbouring state specialising in project preparation.

The majority of the shareholders of the corporation are financial institutions from the private sector. The PDCOR prepares projects and links them to potential investors. The approach makes sense as the private sector is better able to package and pool important projects, whereas the Government of Rajasthan can take policy and reform initiatives. Generally speaking, state governments are best placed to push local governments to adopt the necessary reforms and to undertake project preparations. The state’s role thus becomes enabling rather than directing, serving as a broker and a mediator.


Conclusion

There are many options for financing urban infrastructure, and most of them have been tried in India. The use of such financing options requires a certain political stability, a growing economy and an appropriate legal framework. Once such factors are in place economic development can go very fast as has been shown by China, but also by countries as far apart as Brazil or Tanzania. Indian state governments would be well advised to set up the specialist agencies and enact the prudent regulations that make such growth possible.