By Phalasha Nagpal
The Indian banking sector has been brought to the brink of crisis by dwindling investor confidence—attributed primarily to demonetisation and the new GST regime—which has resulted in a credit crunch, an increase in non-performing assets and diminished corporate lending and private investment.
Failure to meet GDP targets
Amidst all this, the Indian government is still aiming to achieve a new GDP target without exceeding its fiscal deficit. However, the nation’s widening infrastructure deficit limit the government’s ability to work towards these macroeconomic targets. Moreover, India’s demographic dividend makes its infrastructure deficit a grave concern. The growing labour force needs to be productively employed to ensure economic growth. If adequate employment opportunities are not created, India’s demographic dividend will merely be a lost opportunity.
Economic theory and the experience of South-East Asian economies indicate that this growth can only be achieved through gross capital formation, which relies on infrastructure investment as a catalyst for economic development. Currently, the inadequacy of Indian infrastructure is acting as an impediment to growth, particularly in the manufacturing sector. India’s manufacturing sector is operating far below its potential; studies show that for every job created in the manufacturing sector, 2 to 3 jobs are created in the services sector.
The Economic Survey 2017 projected a decline in the industrial sector’s growth to 5.2% in the current fiscal year from 7.4% in the last. This sluggishness can be attributed to the inadequate infrastructure which results in high costs and low competitiveness. A boost through quality infrastructure development would put India on a trajectory to sustainable growth. However, due to its stringent fiscal discipline targets and lack of operation and maintenance (O&M) expertise the government cannot be the sole driver of infrastructure development.
The problem with public-private partnerships
The government has been exploring Public-Private Partnerships (PPP) as a route to direct infrastructure investment since the 1990’s. However, this has had limited success. Around 65 PPP projects worth over Rs 77,000 crore have been terminated according to the ASSOCHAM-SREI study. This is partly due to several disincentives for traditional PPP in the corporate sector.
Firstly, the bearish economic environment in India coupled with dwindling investor confidence makes private players sceptical about partnering with the public sector. Secondly, the inadequate availability of long-term funds along with the virtual absence of a corporate bond market creates an issue with financing. Due to its problem with bad loans, India’s banking sector has not been able to play an intermediary role to fund public-private partnerships. The over-indebtedness of the private sector and its depressed interest coverage ratio further constrain the availability of credit. Thirdly, a weak institutional framework, characterised by bottlenecks and delays in land acquisition, often makes projects unviable due to high-interest rates and construction risks.
When it comes to asset management, the public sector lacks the expertise and political will to invest in O&M. The dilapidated state of public assets is evidence of inefficient management and bureaucratic deficiencies. This makes public asset management a pressing problem. The government must allow the private sector to step in and undertake O&M functions.
The reverse BOT option
An innovative alternative to existing PPP modes, a reverse Build-Operate-Transfer (BOT), would be a better solution than outright privatisation. A typical reverse BOT project requires the government as the first investor. The public assets that the government puts on the table are then taken up by private players which provide O&M without any transfer of ownership. Such public-private partnerships are established on the basis of an upfront fee paid by the corporation which then profits from some or all of the future revenues.
For a long time, India has been suffering from the problem of non-performing public assets, which have only added to the country’s deficit problem. A reverse BOT approach to public-private partnerships allows for a more efficient alternative to privatisation. Furthermore, the method comes with the benefit of offering discounted cash flows to partnering businesses. And after a reverse BOT arrangement, the government can still retain ownership of whatever assets it contributes to the partnership.
Advantages of reverse BOTs
Alternatively, the public sector can still offer direct investment for the creation of new public assets and then opt for a reverse BOT partnership when these are established. In a 2013 working paper from the National Institute Public Finance & Policy, Bose and Bhanumurthy estimated the capital expenditure multiplier on such public investments to be 2.45. This growth potential is facilitated by better access to long-term funds through the government bond market.
Another significant advantage of public investment is the public sector’s ability to expedite land acquisition and other clearances. A reverse BOT allows the government to clear its balance sheet after making its investment and thus to keep its capital output low. After a concession period in a reverse BOT arrangement, the government stands to gain from the residual sale value of any well-managed public asset. Furthermore, such projects help to attract interest from sovereign funds, institutions, and foreign investors.
Since the government undertakes the initial investment in reverse BOT arrangements, private players are further incentivised to participate as they are not burned by the construction risks. However, corporations can achieve O&M efficiencies beyond the standards of the public service on account of their technical expertise and usee of state-of-art-technology.
With the problem of access to private funds solved by the initial government investment and risk-reduction for corporations, there would be a reduction in default rates over time. This would help to strengthen the banking sector and restore investor confidence in the economy. Ultimately, it is the consumers who would benefit from well-managed, safety regulated public-private enterprises. Indeed, the success of good O&M in such projects might become a model for the public sector.
Reverse BOT projects are already underway
India has lessons to learn from both China and the United States, where several reverse BOT projects have already been successfully undertaken. The well-documented Harvard case study of the Semiconductor Manufacturing International Corporation is a good example of one of these.vIndeed, the National Highway Authority of India is set to implement a reverse BOT in roads infrastructure.
Under the Toll-Operate-Transfer (TOT) model, existing highways will be auctioned to interested parties in return for the toll revenue during the concession period. Direct participation by insurance and equity firms, which have access to cheaper credit, would accelerate the process of financial intermediation. Foreign investors such as the Abu Dhabi Investment Authority, Canadian Pension Plan Investment Board and Qatar Investment Authority have also shown interest in these brownfield road projects. In other parts of the world, similar projects like the Penang Bridge and Puerto Rico Highway PR 22 have been successfully implemented.
These projects come with the potential to crowd out private investment on account of the gigantic upfront investment made by the public sector. However, the need of the hour is a fiscal stimulus in infrastructure. In the long-run, reverse BOTs would help to attract higher private investment and thus fast-track infrastructure development.
Government oversight will still be needed
In certain cases the quality of public assets may be too poor, making the project financially unviable for private players. Thus, the quality of the asset plays a critical role in the success of a reverse BOT. A viability analysis of potential projects must be a prerequisite for such arrangements.
However, each reverse BOT project has two other critical aspects that must be kept in mind. Firstly, the performance parameters must be comprehensive and clearly defined. Secondly, an efficient system of monitoring and enforcement for the O&M must be in place. Discrepancies in either of these would create the scope for lapses by the private partner. Since the consumers always associate public asset provision with the government, any shortfall in performance by the private sector is likely to reflect poorly upon the government alone.
Public investments will increase private development
In its current economic predicament, India is looking to boost growth and move higher on the world economic ladder. To achieve this, it is worth exploring reverse BOT arrangements in different sectors of the economy. The success of these would increase private sector confidence in PPPs going forward. In the long-run, this would pave the way for private investment to assume a greater role in infrastructure development.
Needless to say, a proper institutional framework and a designated body for PPP-related issues would be a pre-requisite for the smooth implementation of such schemes. The clock is ticking fast and reverse BOTs seem to be the best way to unleash India’s growth potential.
Please note that the above views are personal and do not represent the views of the government or any other organisation.
Featured Image Source: Flickr
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