India Transformed

by Rakesh Mohan

  As a share of Gross Domestic Product (GDP), fixed investment was 30 per cent in the third quarter of 2015–16, compared with over 36 per cent in as late as the second quarter of 2011–12. According to the Economic Survey, as of December 2014, the stock of stalled projects (of which infrastructure was a substantial part), stood at Rs 8.8 lakh crore, or 7 per cent of GDP.2 This has led to a vicious cycle—as the writers of the survey pointed out—as work on projects comes to a halt and cost-and-time overruns add to the financial problems faced by the developers. This makes them even less willing to commit to future investment, exacerbating the slowdown in the sector.

  Yet, it is precisely at this moment of gloom that it is important to take a step back. For all the problems we face today, Indian infrastructure has taken huge strides forward in a broad range of sectors such as roads, ports, power supply, civil aviation infrastructure (e.g. airports) and urban infrastructure. Whether it is the Delhi metro rail project; the Mumbai, Delhi, Bengaluru or Hyderabad airports; or the investment in roads that led to an increase in the surfaced road length of 58 per cent between 2001 and 2011, even the sector’s severest critics will admit that we are nowhere as bad as we were at the beginning of the 1990s.3

  However, this boom has come at a cost, which we see now. The heart of Indian infrastructure reform has been the public–private partnership (PPP) model, seen as a way to raise funds on a large scale for resource-hungry projects that would otherwise go unfinanced if left to cash-strapped governments. Therefore, any attempt to understand what went wrong must come to grips with how we, as a country, implemented the PPP model, where we made mistakes and what needs to be fixed.

  This essay argues that the fundamental mistake we made was to see the private sector as mainly a way to bring scarce capital into infrastructure, but with little regard to putting in place enabling institutions, laws and processes that could put that capital to effective use. There was a ‘we’ll fix it later’ approach, not least on the part of government bureaucrats, who wanted to see real progress on the ground. As a result, it was only after committing finances, resources and manpower, that developers, bankers and governments discovered deeper, more basic problems with the sector in question. Some of these issues centred around regulation: who was to decide disputes, or handle customer complaints? Other issues centred around the role of the sovereign: should the government acquire land for infrastructure projects, or should the responsibility be that of the developer’s? One result of putting the cart before the horse in this way was that the sector went through a whole cycle. The private sector started out as contractors, progressed to being developers bringing in capital and managing all aspects of a project, and then went back to being contractors as, one by one, many ran into financial difficulties or faced serious hurdles in attempting to build out the project.

  Figure 1: No. of PPP Projects/Project Cost Per Year

  Source: infrastructureindia.gov.in (accessed on 7 June 2016).

  Note: The data cover PPP that were either ‘Under Construction’ or ‘Operational’ as on 1 April 2011 or ‘Awarded’ thereafter, and where project cost was > Rs 5 crore.

  The price of not fixing the mistakes we made will be high indeed. Infrastructure, more than any other sector, is an enabler to the rest of the economy, helping to lower the transaction costs of doing business. The ‘multiplier’ effect on GDP of an acceleration in infrastructure growth and build-out are estimated at 0.5–0.9 by the IMF for developing economies, but can go to as high as 5 for a sector such as the railways.4 A major reason for China’s extraordinary economic growth in the last few decades has been its focus on infrastructure. The country’s infrastructure capital stock grew by 12.3 per cent on average, between 1978 and 2008, compared to a GDP growth of 9.5 per cent in real terms over the same period. ‘Such a remarkable catch up in infrastructure has no doubt made a significant contribution to China’s rapid economic growth.’5

  The rest of the essay is structured as follows: In the next section we look at the developments centring around 1997 and 1998, which kick-started the reform efforts in infrastructure. We also look at the profile of private-sector players who entered infrastructure after its opening up, and how that has changed over the years. We then look at the broad developments in governance and policy that guided the development of the six infrastructure sectors covered in this essay—roads, civil aviation infrastructure, ports, power, railways and urban infrastructure. The learnings from the successes and failures in infrastructure over the last twenty years are covered, including changes in the recent policy environment, followed by suggestions for future reform.

  In this review, we do not cover two major sectors that are arguably seen as part of infrastructure—telecom, and oil and gas. Issues specific to these sectors are addressed elsewhere in this volume.6

  Figure 2: Sector-wise PPP Projects since 1991–92

  Source: infrastructureindia.gov.in (accessed on 8 June 2016).

  Note: Data covers PPP that were either ‘Under Construction’ or ‘Operational’ as on 1 April 2011 or ‘Awarded’ thereafter, and where project cost was > Rs 5 crore.

  1997–98: Year Zero for Infrastructure Reform?

  Reform in the infrastructure sector began to gather speed only in the mid-90s. In 1996, the Expert Group on Commercialization of Infrastructure Projects, chaired by Rakesh Mohan, submitted a key report that outlined the challenges faced in developing Indian infrastructure and how to overcome them. That report was to effectively become a blueprint for reform in the sector; it addressed issues of both financing and regulation, and proposed, among other things, autonomous regulators for each sector, the separation of roles between a regulator and the entities actually operating infra projects, and the setting up of special purpose vehicles (SPVs) to channel funds for a specific project. Even at the time, the committee stressed the need for the different risks in a project to be ‘clearly demarcated and allocated to different stakeholders’.7 This was a prescient warning by the committee and, sadly, successive governments paid little heed.

  The year 1997–98 held the key when a whole set of reforms came together. The Infrastructure Development Finance Corporation (IDFC), which was to play such a pivotal role in financing infrastructure projects, was formed. It was also the year when the Telecom Regulatory Authority of India Act (TRAI) was passed by Parliament, the year when the Tariff Authority of Major Ports (TAMP) was set up, and the private sector was allowed into ports through an amendment in the Major Port Trusts Act.8 Additionally, an ordinance was introduced that brought into being the apex regulators in the electricity sector at both the Centre and state levels.9 And while the National Highways Authority of India (NHAI) was set up two years earlier in 1995, it was in 1997–98 that the capital base of the authority, which was to play a key role in the development of highways in the country, was expanded to Rs 500 crore, even as the giant National Highways Development Project (NHDP) was instituted.

  Parallel to the efforts at the Centre, many state governments also took the initiative to revitalize infrastructure. States such as Andhra Pradesh, Gujarat, Maharashtra and Tamil Nadu were especially entrepreneurial in this regard. Even a state like Punjab, not usually seen as being as dynamic in terms of economic policy as the others in the list, took novel initiatives. The state set up the Punjab Infrastructure Development Board in 1998 under a newly passed state law and staffed it with high-level officials with access to specially earmarked funds raised through cesses. Given legal backing, it bid out PPP projects in a range of sectors—from roads to industrial training institutes to bus terminals.

  The Entry of the Private Sector

  How did the private sector respond to the new opportunities offered by the opening up of infrastructure?

  Even before the opening up of India’s economy in the 1990s, there were a set of private-sector players who had deep experience of, and knowledge in, large-scale infrastructure. These were companies such as Larsen and Toubro, Gammon, and Hindustan Construction Company, who had a hist
ory of executing large-scale construction projects, including in public infrastructure.

  Interestingly, some players in this category were relatively more cautious in their approach, at least initially, towards the advent of PPP projects, given the additional risks the model entailed (such as taking on the onus of financing the project). But with their national, and indeed, even then, international experience in construction, these players were ideally placed to take on the new emerging opportunity, which they did despite their initial reluctance.

  A second group of such players also had strong experience in public works, but were much more regionally concentrated. Chief among these were a clutch of companies from undivided Andhra Pradesh—Lanco, Nagarjuna Construction, and Navayuga, among others—who had specific experience of working on large dams and irrigation projects in the state.

  A third set of players had little initial experience of public infrastructure, to begin with, but had established industrial businesses, which they used as a base to leap into the sector to take advantage of the new opportunities; these included a diverse set of companies such as Zee, Reliance, and GMR and GVK. Unlike the aforementioned groups of players, their initial experience of infrastructure was as developers.

  A fourth set of players also had little prior experience of infrastructure, but had backgrounds in the financial-services industry. These included the likes of IDFC (mentioned earlier) and Srei. In recent years, a subgroup in this category have become prominent investors in India’s infrastructure industry. These are primarily a clutch of foreign private-equity funds such as Blackstone, Brookfield, KKR, and pension funds such as the Canada Pension Plan Investment Board, and PSP (also from Canada). In fact, foreign players such as these now provide the much-needed liquidity and exit opportunities for developers who are heavily weighed down by debt from past projects and have little financial bandwidth to complete current projects or bid on new ones.

  Irrespective of which firm falls in which category players have, however, developed a wide set of learnings from the experience of the last two decades. My own firm, Feedback Infra, is a case in point. It started out as an advisory and consulting firm, helping infrastructure majors’ plan and develop project reports in the early 1990s. In the late 1990s, it moved to designing the first industrial parks then being promoted by different governments. However, it was only in 1989–99 that it positioned itself as a full-fledged infrastructure engineering and technical services company. From then on, it built over a decade’s worth of experience, and it was in this phase that the company came to grips with the nuts and bolts of providing a comprehensive set of services for creating infra assets. In 2010, it moved to explore new opportunities in ‘Managing and Operating’ newly constructed infrastructure assets with three O & M subsidiaries. And it was only last year that it expanded to participate in new projects overseas in geographies such as the Gulf, Africa, South and South East Asia. In different ways, its journey has kept pace with the growing infra opportunities that India and emergent markets are throwing up as the sector evolves; with around 9000 employees, it has clearly emerged as one of the largest providers of infrastructure-related services in South Asia.

  Roads

  With the setting up of NHAI and the introduction of the NHDP in 1998, the stage was set for the biggest build-out of the road network the country had ever seen. Between 1951 and 1991, the total length of surfaced roads grew at the rate of about 24,000 kilometres per year. In the twenty years after 1991, they grew at the rate of about 70,600 kilometres per year, under the combined efforts of two giant road-building programmes, both of which were kicked off between 1998 and 2000.10

  The NHDP poured around Rs 2,02,700 crore into adding or upgrading the country’s national highway network, which, though accounting for just 2 per cent of road length, carries around 40 per cent of traffic. The NHDP and other investments in national highways accounted for about 35 per cent of total investment in the roads sector between 2002 and 2012—a quantum of investment heavily implemented through PPPs using a standard or ‘model’ concession agreement between the NHAI and private developers.

  Concurrently, even as the NHDP set about transforming the country’s highway network, the Pradhan Mantri Gram Sadak Yojana (implemented by states, but under central-government guidelines) was having the same effect on rural connectivity at the local level. Between 2002 and 2012, around Rs 1,04,000 crore was spent under the scheme, leading to an additional 3,50,433 kilometres of rural roads being laid or upgraded under the scheme. Going beyond this, state governments poured an additional Rs 4,28,300 crore into the sector. Funding for highways construction was largely raised from cesses on diesel and petrol paid by vehicle owners.

  The Road Network has expanded sharply in the last twenty years …

  Figure 3

  … Enabling dramatic increases in connectivity to far-flung areas …

  Figure 4

  Source: NTDPC, Volume 2, Part 1, 49–50.

  But while the first two phases of the NHDP went off relatively well, subsequent phases saw a sharp slowdown. The third phase of the NHDP was scheduled to finish by 2012 for instance, but only 54 per cent of the targeted road length had been completed by then. Indeed, in recent years, the NHAI has again begun to implement road projects under the EPC (engineering, procurement, construction) model, with the private-sector player being relegated to the role of a contractor.

  The key problem was an incomplete institutional structure. While the NHAI and the Ministry of Road Transport and Highways (MoRTH) are signatories to PPP agreements, they also manage policy and guidelines for PPP projects, a situation rife with possibilities for conflict of interest. Private developers were also forced to take on tasks, such as acquiring land, for which they were ill-suited.

  Ports

  The development of the Indian ports sector sharply highlights—perhaps even more than the roads sector—how differences in the regulatory environment can affect private participation in a sector. Further, the experience of PPPs in the ports sector highlights the critical role played by state governments in promoting private investment in infrastructure.

  Since the 1960s, there have effectively been two regulatory regimes in the private sector. Twelve ‘major’ ports (the largest in the country) operate under the jurisdiction of the central government, with each port being owned and operated by a trust. Reforms in the 1990s aimed at corporatizing such ports and outsourcing port services to private operators. Tariffs for such services were regulated by a new regulator—the Tariff Authority for Major Ports.11

  The proposed reforms never really got off the ground. Only Ennore port was corporatized, and the lack of freedom to ports to set tariffs proved to be a disincentive to private investment. In 2011, a study into the problems of major ports by a Parliamentary Standing Committee observed, ‘Despite considerable degree of operational powers the port trusts formed under the Major Port Trust Act lack teeth and suffers in executing power and authority.’12

  Under the National Maritime Development Programme of 2005, the government had proposed 276 projects to be implemented between 2005 and 2012, worth a total of Rs 55,800 crore, to modernize major ports, including projects to construct or upgrade new berths, and add satellite infrastructure. Of this investment, 60 per cent was to come from the private sector.

  Actual results have fallen short. Five years into the programme, an EY report noted that only fifty projects (less than one-fifth of what was planned) were completed at a cost of Rs 5700 crore. Among the problems, it pointed to ‘delays in obtaining approvals from the Ministry, in clearance from the Ministry of Environment and Forests as well as state pollution control boards, and in tendering and contract procedures’.13 Forty-five projects worth Rs 18,415 crore were under operation at major ports as of April 2016.14 Yet, despite these failures, major ports have seen improvements in efficiency in the last couple of decades, with average turnaround time for ships going down from 6.7 days in 1991–92 to 3.89 days in 2014–15.15

  The se
cond regulatory regime covered the 200 so-called ‘minor’ ports. These were owned and operated by state governments who proved far more successful in attracting investment. As a result, the minor ports’ share of total cargo traffic handled rose from 25 per cent in 2001–02 to 39 per cent in 2011–12. According to a report by the National Transport Development Policy Committee: ‘This has largely been due to lower levels of regulatory and financial control compared with Major Ports. Non-Major Ports have been more successful in attracting higher private investment, because they are perceived to be more business-oriented, customer-friendly, cheaper and, in general, more efficient.’16 As part of the ongoing reforms in the sector, there is talk of doing away with TAMP altogether and redesigning the regulatory regime.17

  The other big problem facing ports has been the development of satellite infrastructure, such as road and rail connectivity. To fix this problem, the Union Cabinet recently approved the Sagarmala project, which aims at development of ports and local industrial clusters with satellite infrastructure. Under this project, 104 initiatives worth around Rs 70,000 crore have been proposed.18

  Power

  Of all the sectors covered in this essay, it is perhaps the power sector that saw the strongest institutional development in the early years of reform. Based on policies first introduced with the help of the World Bank in Odisha in the mid-1990s, the reform process essentially involved ‘unbundling’ of vertically integrated public-sector power utilities into separate entities involved in generation, transmission and distribution of power. The idea was to bring private-sector participation in each of these entities over time, with an independent regulator overseeing the sector, arbitrating disputes, and being responsible for consumer interests. In 1997, the government introduced an ordinance setting up such independent regulators at the central and state levels. The Electricity Act in 2003 was a major piece of legislation, which embedded in law many of the reforms in power that had been proposed in earlier years. The ultimate aim was the creation of a single national ‘market’ for power with multiple buyers and sellers.