The author is former governor, Reserve Bank of India
In his critique of the latest budget, Manmohan Singh implicitly raised a question as to where exactly Jaswant Singh had provided for the massive infrastructure investment indicated in the budget. This question reflects a legitimate concern. It is, however, a fact that the finance minister has adopted an ingenious but elegant method of financing infrastructure investment through public-private partnerships, which would build projects on a “build, operate, own and transfer” basis. Such public-private partnership will raise funds through suitable financing vehicles leveraging relatively small public contributions to raise funds for meeting the expenditure on infrastructure. Prima facie, the budget has leveraged about Rs 2,000 crore of provision to make up the investment of nearly Rs 60,000 crore through equity and debt financed by such public-private partnerships.
The mathematics of Jaswant Singh’s budget may raise many eyebrows. It is, however, a realistic initiative in the context of abundance of liquidity in the financial sector and the felt need for infrastructure. The model Jaswant Singh has followed is apparently derived from Chinese experience, where a number of special purpose vehicles, including town and village enterprises, have raised large sums of money from the Chinese banking system to build infrastructure and industry. A key to the success of this proposal, however, lies in the determination of the government to raise user charges adequately to pay for instalments of principal and interest that fall due. This is critical, especially in the light of the fact that Jaswant Singh has ruled out issuance of any government guarantees. He has, however, indirectly involved the government by providing for a subsidy to bridge viability gaps. This is an open-ended commitment which may ultimately spoil the government’s overall fiscal picture. If the expected returns do not materialize, care is called for.
The government has to ensure that the local communities benefiting from the proposed investments are fully involved in working out the increased tariffs and user charges. Experience in respect of toll roads, where subsequent to the completion of the roads, tolls could not be collected, leads one to fear that a similar fate may await some of the infrastructure projects. This has to be avoided by a conscious process of involvement of the communities concerned and their association in the finalization of concession agreements for the projects.
Even more crucial to success is the willingness and ability of the financial sector to undertake financing of such infrastructure projects. The experience so far has been mixed. All-India financial institutions have, ever since the emergence of universal banking, shied away from long-term lending and preferred to concentrate on retail finance. This unfortunate fall-out of the reform process has led to the “long-term financing role” of the all-India financial institutions getting submerged. A developing country like India cannot afford to do without institutions dedicated to long-term finance, given a weak equity market.
The government and the Reserve Bank of India need to incentivize the larger financing institutions, such as Industrial Credit and Investment Corporation of India, Industrial and Development Bank of India and Infrastructure Development Finance Company, to take legitimate risks in financing infrastructure projects. The finance minister has provided for the following infrastructure investments in his plan: new road projects at an estimated cost of around Rs 40,000 crore, the National Rail Yojana Project costing Rs 8,000 crore, renovation and modernization and two airports and two seaports at an estimated cost of Rs 11,000 crore, global standards convention centres at an estimated cost of Rs 1,000 crore.
The financial institutions and banks may have a legitimate fear that they may be found fault with at a later stage if their financial decisions go wrong. This fear of failure is a key to the delays in decision-making by financial institutions. Incidentally, Jaswant Singh himself has commented recently on this indirectly. Referring to the defence ministry surrendering large sums of money during the current year, Jaswant Singh has laid the responsibility on the “C(3)” factor, consisting of the Central vigilance commission, the comptroller and auditor-general and the Central Bureau of Investigation. While he does not deny the need for these institutions to rule out malfeasance, he points out that fear of their enquiries leads to paralysis of decision-making in government, and by extension, I would say, in the public sector.
The government has to involve the key elements of the “C(3)” factor in an educational process to ensure that they realize that excessive pursuit of minutiae of decision-making leads only to further costly delays and wasteful expenditure. They have to be trained to isolate genuine cases of malfeasance from bona fide errors. While the government has taken a few steps, such as the setting up of Serious Frauds Bureau to eliminate harassment of bona fide executives in the financial sector in particular, much remains to be done to prevent undue persecution of decisive executives in the public sector in general and the financial sector in particular — an essential prerequisite for the success of the finance minister’s innovation.
The finance minister’s adoption of a new device for financing infrastructure is motivated by a defensive response to the reformers’ self-imposed fiscal deficit constraint. A fiscal deficit constraint in the shape of a specified number as the target for fiscal deficit to gross domestic product ratio forces the government to restrict budgetary investments for even desirable purposes, such as infrastructure.
Incidentally, this has been at the root of the controversy that is raging in Europe over the achievements of fiscal deficit to GDP ratio by both Germany and France. Economic growth and employment necessarily involve governments in an effort to stimulate the economy by providing investment funds. If such efforts naturally lead to fiscal deficit targets not being reached, so much the worse for the targets. The finance minister’s proposed solution gets round this problem.
If the finance minister had provided for infrastructural outlay of Rs 60,000 crore and odd fully in the budget, he would have clearly broken the fiscal deficit to GDP ratio target. His financial engineering in the shape of public-private partnership, which can raise resources from the financial sector to meet the needs of the infrastructure, is a clever solution.
Critics may point out the risks that this alternative option poses if there is a failure to raise adequate revenues to repay the loans raised. In that event, the model may be impaired and even hinder further prospects of such infrastructural investments, apart from irretrievably affecting the health of the financial sector. Care has, therefore, to be taken by the finance ministry to ensure that apart from speeding up decision-making of the financial institutions, the state governments and local bodies, which set up the new vehicles for BOOT operation, are fully involved in the process of ensuring levy and collection of appropriate user charges.
At the moment, however, there is an imperative necessity to change the mindset in the financial sector, which is afraid of taking quick decisions, especially in the light of the pressures by the regulator in regard to non-performing assets. In the new model of public-private partnership, the private sector of the partnership takes the risk only in respect of its equity contribution. The public half, representing the government, and the institutions, bear the risks in so far as the debt side is concerned. The financial institutions are new to this sector and have to be encouraged to reduce bureaucratic delays in decision-making.
Raising equity for these new projects is also not going to be easy. Long-term investors, like insurance companies, are a potential source for equity investment on such projects. The government will do well to tap the insurance sector for investment in equity in the proposed infrastructural projects. So far, the Life Insurance Corporation of India has been used to investing mostly in water supply and housing projects. It has to expand its portfolio to include the new areas which the finance minister has indicated. So too, the newly emerging private insurance sector will have to be induced to invest in the equity of these projects. Assured returns of a decent nature can definitely be offered by the infrastructural projects provided they are well-designed, properly implemented and efficiently run.
There is also scope for attracting foreign direct investment in the proposed infrastructure initiative. There is, however, the shadow of the fate of Bechtel-GE venture in the Dabhol projects. The sooner the financial sector in India cleans up the mess created by the Dabhol episode, the better would be the prospects of attracting further foreign investments in India’s infrastructure.
To sum up, the finance minister has embarked on a bold path for energizing investments in infrastructure in India and thus spurring the economy forward. He has dared to breach the conventional wisdom, which would have confined him to budgetary resources. But, by the same token, his new path requires that the North Block should specially concentrate on energizing and incentivizing the somnolent financial sector of India to participate in the projects for infrastructural growth. On this would depend the success of Jaswant Singh’s innovative budget and the future growth of India’s economy.