by Rakesh Mohan
Figure 5: Average Turnaround Time for Ships in Major Ports
Source: NTDPC, Volume 2, Part 1, 55; Data for 2014–15 from ‘Port Sector at a Glance’, Basic Port Statistics of India, 2014–15, Government of India.
The setting of power tariffs was, and is, a deeply political issue. State governments kept low the tariffs charged to important political constituencies such as agricultural users or domestic consumers, with tariffs over time falling well below the cost of supply. To offset this, tariffs on industrial consumers were kept high. Despite this, the difference was rarely made up, and state power utilities faced chronic deficits, leading to multi-thousand crore losses. It was hoped that the newly created ‘independent’ regulators would enable the setting up of a tariff structure that was far more rational and less riddled with cross-subsidies, thus leading over time to state utilities achieving financial viability.
In actual practice, successes have been few and far between. State regulators have often not turned out to be as independent of state government control as needed. Further, in a number of states, distribution companies have remained state-owned. The end result has been that the biggest buyers in the national ‘market’ for power have been chronically bankrupt and have remained so.
Despite this, the years after 2003 saw a flood of investment, especially in generation. As in roads, a model concession agreement (MCA) set the framework for governance under which the private-sector generation companies operated.
But ultimately, the private sector ran into three serious problems. First, the flood of investment into power generation presupposed adequate domestic supplies of coal. However, the coal sector had seen little reform, with the state-run Coal India having a monopoly over coal mining. There was also an opaque policy by which domestic coal was allocated to buyers. In such an environment, a desperate rush to secure cheap, domestic supplies of coal set the state for a major corruption scandal, involving the coal market. When domestic supplies dried up, power projects turned to international markets to buy coal at a time when global coal prices as much as tripled between 2006 and 2011.19
The second problem that projects faced was that their ability to revise power tariffs in line with increases in the coal price was severely limited by conditions in the MCA. Thus, most private-sector thermal power projects were unviable from day one.
Finally, in power, as in other sectors, the inability to demarcate risks under a PPP contract correctly meant that the private sector was saddled with tasks it was unfit for, such as acquiring land or getting environmental clearances. As a result, many projects stagnated for years and still do.
Efforts were made to fix these problems. The government subsequently allowed power-purchase agreements to include clauses allowing for tariffs to track increases in the price of coal. So-called ‘Ultra Mega Power Projects’ were bid out to private developers only after putting in place environmental clearances and with clearly identified captive coal mines as a source of supply.
Civil Aviation
Of the eighty-four operational airports in India, six airports situated in India’s largest cities (and accounting for 60 per cent of air traffic) are operated under PPP mode. A further eight are privately run or run by respective state governments, with the remaining being operated by the Airports Authority of India (AAI), a state-run institution. There has been a separate independent regulator for airports since 2007, governed by its own legislation. The Airports Economic Regulatory Authority also has the power to set various fees and tariffs imposed on passengers by airports.
From one perspective, the private sector’s involvement in the airport sector has been successful. As a recent report on the transport sector in India has pointed out: ‘These airports are not just fit-for-purpose but are comparable with the very highest international benchmarks on several fronts.’20
However, the same report also pointed out that landing and usage fees at the new, modern airports are among the highest in the world.21 Increases in fees sought by airport operators have ranged from 100 to 400 per cent and has led to widespread complaints from both airlines and passengers. Part of the problem is due to the fact that some tariffs were held constant from 2001, and so, when they were raised, had to be hiked substantially to compensate. Even so, the report concludes that while it is fair for development of airports to be funded by user charges, the development of modern airports, ‘have been achieved at a price that may be considered untenable’.22
Railways
Of all the sectors covered here, it is the railways that have seen the least structural reform and the poorest performance in terms of attracting private investment. The main reason for this failure, as a major report on railways restructuring issued last year pointed out, was the fact that three critical roles—policymaking, regulation and operations—were all vested with the Indian Railways. ‘There is a clear conflict of interest when the policymaker and regulator is also a competitor. As long as this is the case, private players will always suspect that the schemes are tilted in favor of [Indian Railways] or one of its PSUs.’23
At least since 1992, there have been various attempts by railways to involve the private sector. Schemes to get the private sector to own and lease wagons to the railways (thus augmenting rolling-stock) or schemes to get the private sector into operating special types of trains (container trains, freight trains, etc.) have been proposed at various times, but have seen only mixed success.
A major reason has been that such schemes, in different ways, favoured the Indian Railways’ own services. Often, high user charges were imposed by the Indian Railways on private operators for use of railway infrastructure. A lack of coordination between different railway zones added to problems in implementation.
Another major project by the railways, aimed at involving the private sector, is the Dedicated Freight Corridor project, initiated in 2005, which aimed at creating specialized routes for freight trains on certain routes. This has been a key problem for the Indian Railways since freight and passenger trains run on the same line, thus creating blockages in freight movement. Again, there has been lack of action on the ground, with policies favouring the Indian Railways over the private players.24 Delays in tendering, land acquisition and frequent changes in management have also bedevilled the project.25
The slow progress in adding to infrastructure in the railways has meant that more and more freight traffic, the railways’ main revenue source, has moved to the roads network. The railways’ share in total interregional freight traffic has fallen to 30 per cent in 2007–08, from 53 per cent in 1986–87.26 The roads sector has received well over 60 per cent of funds channelled to PPP projects since 1991–92, compared with less than 1 per cent for railways (see Figure 2).
Figure 6: Share in Interregional Freight Traffic (%)
Source: NTDPC, Volume 2, Part 1, Table 2.6, 38.
Urban Infrastructure
The bulk of urban infrastructure projects in the PPP mode have been in the field of transport—especially metro rail. These include the Hyderabad and Mumbai metro projects, the Gurgaon rapid metro and the Delhi metro’s airport-line project. More recently, the current government’s smart-cities project and the Atal Mission for Rejuvenation and Urban Transformation covering 500 cities were successors to the earlier Jawaharlal Nehru National Urban Renewal Mission, which was the first large scheme to encourage states to use the PPP mode to improve urban infrastructure. Since 1991–92, around Rs 43,000 crore of urban projects have been executed in the PPP mode, with over Rs 33,000 crore being in metro rail alone.27
However, successes outside metro rail have been few and far between. The regulatory framework governing the build-out of urban infrastructure can often be the most complex and difficult of all to design and implement. Large cities have multiple agencies with overlapping jurisdictions on land ownership and development and other critical municipal functions. A private developer looking to implement such a project must not only deal with such agencies but with well-entrenched and influent
ial special interests. ‘Lack of urban planning, and clear laws, regulations and procedures has resulted in a slowdown of urban infrastructure projects,’ a recent committee, chaired by Vijay Kelkar and set up to recommend changes to India’s PPP model, pointed out.28
It is in such urban infrastructure projects that the role of state governments is paramount. Projects in water supply and sewerage are very much issues under the ambit of state governments, rather than central governments. Apart from this, the multiplicity of clearances and regulations affecting such projects are typically under state-government control.
Problems with the PPP Model
What were the flaws with the PPP model in India, which led to multiple projects facing a cash crunch, bankers facing the risk of loans not being paid back, and developers on the brink of bankruptcy? All three of the major stakeholders in a PPP project—the government, the private developer, the banks—must share the blame.
When PPP projects first started being bid out, they were met with scepticism from potential private-sector players who were wary of the broad set of risks, including financial ones, that the model entailed. Subsequently, however, they shed their inhibitions and embraced the PPP model, mainly out of a fear that if they remained contractors, they would be rendered redundant. Certain other groups also wholeheartedly embraced the PPP model as they saw an opportunity for gaming the system with ‘cronyism largesse’ and cosying up to the political establishment.
This fear of being left out of the race for projects that competitors were bidding for, or the lure of quick riches, meant that investments were often taken on with little regard for potential problems—not just in individual sectors but in the overall design of the contract. The pipeline of projects offered for bidding in most sectors has often turned out to be erratic, leading developers to be even more aggressive in attempting to win the few projects on offer.
In the race to bag a project, private developers often bid in a way that seemed ‘irrational’ and at levels that made it virtually impossible for a project to be viable. Why did this happen? Many such ‘irrational’ bids were made on the basis of projections that were unduly optimistic. But in some cases, such ‘irrational’ bids were made because the private developer was confident that they would be able to ‘renegotiate’ contract terms subsequently—and on more favourable terms—due to political connections.
Further, as a recent report on PPP projects pointed out, many developers also gamed the system, having little to lose. ‘By inflating the Total Project Cost (TPC), developers achieve financial closure at an amount substantially greater than reasonable TPC and thereby source higher debt than the actual requirement. If the project is then jeopardized, the funds at risk are those of the lenders as there is virtually no “skin in the game” by the developer.’29
Compounding this problem was the source of funding. In India, unlike in the rest of the world, infrastructure was funded to a major extent by commercial banks. This created the potential for serious ‘asset–liability mismatches’ since banks raise funds from depositors for tenures of at most seven to ten years, while infrastructure projects pay off over a much longer period of thirty years or more.
Yet, this problem (flagged by numerous experts and observers) was ignored and commercial banks were encouraged to fund infrastructure projects in India. Indeed, the share of bank loans to infrastructure projects rose from 13 per cent in 2002 to 31 per cent in 2015. Moreover, banks were also afflicted by the ‘me-too’ syndrome that affected developers. They rushed in to fund projects whose economics were questionable from the very beginning. If Indian banks are reeling from non-performing assets (NPA) to the tune of Rs 2,64,200 crore currently, they must bear a large share of the blame themselves. And if developers were indeed gaming the system—as the Kelkar Committee Report recognized—the oversight on project costs that financiers should have exercised was not forthcoming.
Figure 7: Share of Infrastructure in Bank Loans to Industry
Source: Reserve Bank of India.
https://www.rbi.org.in/Scripts/PublicationsView.aspx?id=15170, https://www.rbi.org.in/Scripts/PublicationsView.aspx?id=16491. Accessed on 6 September 2016.
Note: Data excludes telecom. Definitional changes mean data may not be exactly comparable before and after 2009.
If developers and bankers were knee-deep in problems of their own making, successive governments added to the problem. As pointed out earlier, policymakers saw PPP primarily as a source of scarce capital to develop infrastructure. Ironically, this is precisely the reason that makes PPPs unnecessary, since governments can often raise funds at lower costs compared to private developers.
In seeing PPPs as a channel through which private-sector funds could flow into much-needed infrastructure projects, government ignored the critical need to build institutions that would enable that capital to be deployed effectively. The measures to ensure that the private sector would not be called upon to bear risks for which it was ill-equipped (acquiring land or getting environmental clearances), and the measures for an independent regulator who would impartially decide disputes between the private developer and the government were either implemented incompletely, or not at all, in many sectors. The general attitude within governments was to focus on getting the investment in and then set about fixing the regulatory and policy environment.
As a result, when difficulties such as those over acquiring land, securing environmental clearances et al. became manifest from the late 2000s onward, the private sector increasingly began to see the government as having ‘abandoned’ them to solve such problems on their own. This was when, as roads minister in the current government, Nitin Gadkari, pointed out in an interview last year: ‘I feel 90 per cent of the projects were stalled because of the government either at the Centre or in states.’30 Overall, there was a sense within the private sector that it was not being treated as an equal partner in a given project.
Finally, the MCA system was far too inflexible. It applied a ‘one-size-fits-all’ solution to projects in a sector. There was little recognition of, and little allowance for, nuances and differences across projects or for the ability to renegotiate terms in case of unforeseen events. The Kelkar Committee acknowledged this problem and laid down a basic framework to govern such renegotiations, including allowing such changes only if there was a clear danger to the project from events beyond the private sector’s control, and when such changes did not materially affect the risks taken on by the government.31
Measuring Investment in Infrastructure
There was one more key failure in institution-building on the part of the policymakers that was perhaps even more fundamental. For a long time, there was no clearly defined way set out by national statistical agencies or other policymaking bodies on how to measure capital formation in infrastructure. With such a methodology lacking, there was no way to set national targets on infrastructure investment, or to measure the extent to which those targets were being met. In a foreword to an earlier book by the current author, former Planning Commission vice chairperson Montek Singh Ahluwalia acknowledged this problem and introduced such a methodology (see Figure 8).32 However, while estimates of capital formation in infrastructure based on the new methodology were computed and released initially, the effort soon petered out and has not yet been revived.33
New Opportunities
Even as projects under the PPP mode have gone into steep decline, almost by default, governments have stepped in—or stepped in again—to fill the gap.
In his 2015 Budget, Finance Minister Arun Jaitley announced the creation of a National Infrastructure Investment Fund (NIIF) with an ultimate corpus of around Rs 40,000 crore to provide long-term capital to infrastructure projects, including stalled ones. This comes at a critical time when bank funding to infrastructure has virtually dried, as funders grapple with NPAs. Notwithstanding other sector-specific initiatives such as the Sagarmala project mentioned earlier for the ports sector, or the fact that the NHAI has once again begun to res
ort to the EPC mode to revive investment in highways, newer opportunities are beginning to emerge for private-sector players.
Figure 8: GCFI (% of GDP)
Source: Planning Commission.
For instance, one area long neglected in infrastructure investment has been the issue of maintenance of infra assets that have already been completed. Such maintenance is critical if the asset is to last as long as was envisaged in the original concession agreements. The infrastructure boom in the 1990s and up to the mid-2000s has created a large pool of such assets, which need to be maintained on a regular basis; this affords a big opportunity to a range of players to specialize in this sub-sector of infrastructure.
The attempt by banks to clean up the mess of NPAs in infrastructure has also begun in earnest, with a number of investors looking to set up specialist funds targeting stressed assets even as the government has announced it will inject further capital of up to Rs 23,000 crore into state-owned banks. The RBI is playing its part by formulating new schemes and creating new avenues through which banks can get rid of, or revive, their bad assets. While the NPA problem in the Indian banking system extends well beyond infrastructure, fixing the problem remains a top priority if investment has to flow into infrastructure again. Meanwhile, a host of foreign investors, including international sovereign wealth funds and pension funds, have been actively scouting for infra assets in India for some time now. The payoffs from these assets are well suited to the long-term investment horizon of such funds.
The Way Forward
Fixing the NPA problem or reviving investment through the EPC mode can go only part of the way towards solving India’s infrastructure deficit in the long term. Fixing institutional problems is key, not just to revive sentiment in the sector but to ensure that the problems we saw in the last decade or so do not reoccur. Here is what must happen:34