India needs to get much more serious about reviving private participation in infrastructure

The private sector has played a key role in India’s growth trajectory. In infrastructure, public-private partnerships (PPP) have especially helped address financing gaps. However, over the last decade, the share of private investments in the sector fell from 37% in 2008 to about 25% in 2018. Immediate measures are necessary to reverse this decline and enable higher private participation in infrastructure.

In the past, lack of dedicated institutions to oversee the sector delayed critical decisions. There is an urgent need to establish an autonomous ‘3P India’ as a centre of excellence for PPPs, to facilitate sophisticated contract models, develop quick dispute-redressal mechanisms, and build capacities, while mainstreaming PPPs in the country.

Clean It Up

Due to the long-term nature of PPP contracts, uncertain market conditions and lack of capacity among stakeholders, disputes are bound to arise during the lifecycle of projects. This often results in delays and freezing of funds in the absence of an efficient and credible countrywide dispute resolution mechanism.

An institutional arbitration ecosystem should be developed and promoted by creating a trained pool of competent arbitrators, uniform and regularly updated standardised flow of procedural rules, minimalist judicial dispute framework and regular adoption of institutional arbitration in domestic transactions.

Countries such as Britain and Australia have developed institutions and processes to identify, prepare, procure and manage PPP projects. In Australia, all levels of government have endorsed PPP and now apply the ‘National PPP Policy and Guidelines’ to projects released to the market. India, however, is yet to adopt these learnings.

The PPP toolkit, developed by the finance ministry, should be endorsed and applied consistently across all levels of the government. The size of investments should be preferred over number of projects, and big-ticket projects, which create value for money, should be prioritised.

The second important driver is encouraging long-term financing from institutional investors, which are required for projects with long gestation periods.

Banks, which have been a major financier, are slowly retreating from PPP lending due to asset-liability mismatch, restrictions posed by Basel-3 norms and high levels of non-performing assets (NPAs). Globally, long-term capital is raised via capital markets, where major investors are pension funds and insurance managers.

Today, Canada and Australia are frontrunners in pension fund allocation to infrastructure — approximately 5% compared to the global average of around 1%. Investment norms and portfolio limits are relaxed in Canada, with no ceiling on investments in various asset classes.

In India, however, the norms are quite stringent. Here, the regulation stipulates that life insurers invest up to 15% of their fund in infrastructure firms and prohibits companies from investing in projects rated below AAA. These norms could be relaxed in a rational way by creating a risk fund that is owned by the government, as suggested by Insurance Regulatory and Development Authority former chairman J Hari Narayan.

Despite the relaxation of limits by the government, FDI in infrastructure has not grown as expected, partly due to sluggish domestic investments. Measures are required to revive domestic investments since foreign investors generally follow domestic trends.

A larger share of government lending could reinvigorate confidence among banks and foreign investors in greenfield projects, even if it means GoI indirectly bears a part of the risks. Existing lending norms should be reassessed in line with models prevalent in mature markets.

Bond Helps

For instance, as per the Transportation Infrastructure Finance and Innovation Act (TIFIA) in the US, the government provides up to 30% of the project finance on subordinated terms, thereby increasing the rating of the project and making it more attractive for commercial lenders and bond holders.

When the project becomes operational, government’s debt could be refinanced with capital market debt, thereby creating space for bond market to flourish. GoI could complement these reforms with procedural and regulatory changes to maximise benefit from such a model.

Further, foreign investors are averse to assuming demand risks in current market conditions. Therefore, ‘government-pays’ PPPs should be a preferred model of project implementation.

India witnessed a cycle of aggressive bidding by private players between 2009 and 2012 under the PPP model, a major reason for delays or cancellation of projects. However, the authorities lack the capacity to assess whether a bid is aggressive or otherwise.

A framework for authorities to analyse the lowest bid with respect to internal estimates and to reject any bid outside the prescribed range will help.

Alternatively, any outlier bid could be scrutinised further by the authority or any institution constituted to assess the project’s viability and validity of assumptions. Authorities should have the right to substantially increase the earnest money deposit (EMD) amount of selected bidders whose bid is considered as an outlier.

Bid capacity should be given due consideration during evaluation and the number of eligible players for financial opening should also be limited.

Finally, it is important to diversify PPPs across sectors. PPPs in India have largely been concentrated in the transport sector, especially roads. The sector is no longer attractive for investors and a large number of road projects are stuck. There is an opportunity to revive PPPs in other sectors such as water and sanitation, health and education.

This article first appeared in The Economic Times on 28 October, 2019