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Soumen Bagchi

SEVERAL research studies and various committees and commissions appointed by the Government have estimated the investment requirement for financing the ever-increasing demand for infrastructure services.

There is little doubt that the investment need is substantially higher than there is provision for in the Government's budgetary allocation.

In spite of an overwhelming demand for investment in infrastructure, its provision has largely remained within the purview of the public sector because of such inherent characteristics as non-excludability, externality, huge capital investment, long gestation period, etc. This is mainly due to two reasons.

The Government hitherto had the idea that private operators might exploit the natural monopoly of infrastructure/utility services.

Moreover, it did not interest the private operators very much because of the huge risks involved in infrastructure projects and the low return during the initial years of investment.

Financing mechanisms

Since the reform process began in 1991, and with the removal of the various restrictions in industries during the licence raj, it was realised that the infrastructure sector also has to be opened to private operators to meet the increasing investment needs. Moreover, the Government also realised that alternative financing mechanisms had to be developed to meet these needs.

The alternatives sought were in the form of funds available from the domestic capital market, foreign funds and private participation. The use of domestic market funds was restricted due to the underdeveloped domestic capital market, which does not provide funds for the long run required for infrastructure projects.

The recent phenomenon of globalising financial flows, which has integrated the financial markets all over the world, has often been seen as a solution towards financing long-term capital investments in infrastructure projects. Such initiatives in India have, however, remained limited due to the very composition of foreign capital inflow and the nature of the sectors that largely attract these funds.

The flow of foreign funds to India was largely in the form of short-term portfolio investments rather than long-term foreign direct investments, which could be utilised for financing infrastructure projects. Portfolio investments accounted for as much as 60 per cent of the total foreign investments in India in 1999-00.

Electrical, engineering and electronic goods accounted for the major share of FDI flow into India between 1991 and 2000. In 1999-00, these three sectors accounted for a major 31.5 per cent of the total actual FDI flows. FDI was rarely available for infrastructure projects. None of the infrastructure sectors figured in the first 10 major sectors that attracted FDI flows during 1999-00.

However, a major portion (46.7 per cent) of total FDI approvals between 1991 and 2000 were for the power, fuel and telecom sectors.

Moreover, significant variation existed in the amount of FDI approvals and its actual flow.

In 1999-2000, the actual flow accounted for a meagre 52 per cent of total approvals during the year. Further, the FDI was largely in the form of mergers and acquisitions.

Is private participation a solution?

Thus the Government was left with the sole option of seeking private investment for financing capital investment in the infrastructure sector. However, the hitherto existing structure of infrastructure provision in India never interested the private sector.

As a result, the Government came up with large-scale sector reforms to facilitate private participation in various infrastructure sectors — power, telecom, roads, oil and natural gas, shipping and urban infrastructure. Table1 provides the details of the reform measures and achievements in various infrastructure sectors during the past few years.

In spite of several reform measures in the infrastructure services, private participation has remained negligible in the whole South Asia region (Table 2). India is no exception in this regard.

However, port, telecom and power are three infrastructure services where the South Asia region has succeeded in attracting moderate private investments. Ports have been a major success so far as private investments are considered. The share of private investments in port infrastructure services for South Asia largely remains concentrated in India and Pakistan only.

Private financing in developing countries

This trend has largely been a result of the lack of risk capital with the government, required at the initial stages to absorb various risks involved in infrastructure projects.

Further problems in this regard arise due to the absence of sufficient statutory support to facilitate private participation.

Both at the level of Central and the State governments, there have to be separate Infrastructure Acts to make cumbersome processes simple and transparent. This Act would specifically address the issues pertaining to individual infrastructure sectors.

To conclude, one can suggest the following top concerns for private participation for infrastructure projects in India:

Separate statutory provisions for different infrastructure areas, addressing sector-specific issues.

Need for a change in tax treatment for service industries.

Adaptation of tax advantages for high-risk development costs in private participation for infrastructure development.

Creation of development finance institutions (DFIs) to facilitate fund arrangement, as in most of the OECD countries.

DFIs, on behalf of the government, should provide risk capital and technical expertise during the early stages of project development, prior to financing.

DFIs should be made responsible for arranging debt and equity funds for infrastructure projects.

(The author is a Senior Analyst with ICRA Advisory Services.)

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