PRESENTATION AT THE ICRIER SILVER JUBILEE SEMINAR

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PRESENTATION AT THE ICRIER SILVER JUBILEE SEMINAR
Rajiv B. Lall MD CEO, IDFC
NEW DELHI November 6, 2006
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GOVERNANCE IS KEY

• Governance is the fundamental theme that cuts
  across all aspects and segments of infra
  development challenge
• Inter Departmental Issues
• Centre State Tension
• Rural Urban Divide
• Public Private Competition
• Infra development is especially vulnerable to
  conflicts and tensions in these four dimensions
  -- their resolution is all about governance

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Governance must improve to meet the new challenge

• Our ability to implement reforms, and indeed our
  choice of reform options is constrained by the
  reality of our political economy and the quality
  of our governance
• Theoretical, first best solutions are a useful
  beacon, but reform initiatives must be designed
  and sequenced taking due account of the realities
  of political economy
• However, it is not possible beyond a point to
  design measures that skirt around poor
  governance. The bottom line is that we will not
  be able to meet the challenge of infrastructure
  development unless we tackle governance

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The infrastructure agenda

• Finance
• Roads and ports
• Urban
• Power
• Capacity building

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Infrastructure Financing Context
Infra spend (GFCF) 2005/06 of GDP USD 2010/11 of GDP USD
Central Govt 0.5 4b 1.0 12b
Central PSUs 2.1 17b 3.0 35b
State Govts their enterprises 1.0 8b 1.0 12b
Private Sector 0.9 7b 2.5 30b
Total o/w Financed through 4.5 36b USD 350b over 5 yrs 7.5 90b
Govt Bonds 1.7 14b 2.0 24b
Domestic credit o/w from Banks 1.5 12b 0.8 6b 3.0 36b 1.2 12b
Pvt. domestic equity finance 0.3 2b 1.0 12b
Internal accruals 1.0 8b 1.5 18b
Domestic Savings/GDP 30 34
Financial Savings/GDP 15 19
Infra spend/Financial Savings 30 37.5 39
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Infrastructure Finance Context

• Domestic savings seem tight although the
  constraint is not insurmountable
• Foreign savings (current account deficit) of
  about 2 should be enough to sustain a higher
  investment ratio, provided domestic savings
  effort improves through demographics and FRBM
• Overall savings effort may not be a challenge,
  but intermediation will be
• Priority to foreign equity capital -- will need
  0.5 percent of GDP per year
• In addition targeted access to long term debt
  finance from overseas would help
• May not be possible/ desirable for domestic banks
  to finance growing share of infra financing
  needs need for other channels of intermediation
• In our base case, infrastructures share in
  incremental bank credit would have to more than
  double from 8 to over 36 gt exposure limits?
• Banks will be equity constrained (especially
  after Basle II) to fund non recourse loans
• ALM (duration) mismatches will make banks
  vulnerable to interest rate risk

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Infrastructure Finance Recommendations

• Encouragement to domestic and foreign financial
  investors for equity capital
• Allow insurance companies and PFs to invest in
  funds and/or SPVs owning infrastructure assets
  (relax requirement of dividend history for such
  investments)
• Allow minimum funds under management as
  eligibility criterion instead of net worth for
  financial investors bidding for infra assets
• Implement recommendations of Patil Committee on
  debt capital markets especially with respect to
  development of market for securitized assets
• Allow insurance companies, PFs and IIFCL to buy
  investment grade securities of long term
  infrastructure focused CLOs and CDOs
• Allow FIIs to buy tranches of long term
  infrastructure focused CLOs and CDOs
• Encouragement to infrastructure focused NBFCs
• Allow these NBFCs automatic access to ECBs at
  least from multilaterals and reputed regional
  financial institutions
• Allow insurance companies, PFs, and IIFCL to
  invest in long term investment grade bonds issued
  by these NBFCs

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Road and Ports Sector Context

• First generation initiatives reasonably
  successful
• GQL in roads, privatization of berths in major
  ports, development of private minor ports
• Next generation of challenges
• Central government institutions unprepared for
  scale of PPP engagement needed in the sector
• Confusion between role of government as policy
  maker, regulator and operator
• State level focus/resource allocation to
  road/port development very patchy
• Inter-modal connectivity and competition issues
  have been neglected with risk of new bottlenecks
• 124,300 km of State Highways constitute 4 of
  road network and carry 40 of traffic (similar to
  NH traffic share) are grossly under funded

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Road and Ports Sector Recommendations

• Focus MoSRTH on policy making framework allow
  NHAI and Port Trusts greater autonomy and clear
  responsibility and accountability for execution
• Training and infusion of professional expertise
  in PPP management and project development for
  NHAI and Port Trusts is critical
• Strengthen legal provisions with respect to
  ability of NHAI and Port Trusts to contract
  independently with private concessionaires the
  National Highways Act, NHAI Act, Indian Ports
  Act, Major Ports Act
• Create strong and independent dispute resolution
  capacity
• Formulate national integrated transport policy
  framework
• Create inter-ministerial (roads, ports, rail and
  airports) forum/group to develop and review
  inter-modal transport policy blueprint on regular
  basis

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Road and Ports Sector Recommendations

• Focus on State Highway development
• Central government can play a more active role in
  steering state level road development and
  formulating a common framework
• - Would reduce states time and efforts to
  initiate a medium term investment program.
• - To include models for road development policy,
  state highway act and road funding.
• All states to prepare a road data base and master
  plan for road development and maintenance by all
  states
• Create state highway authorities with modern
  management systems and set up state level
  dedicated road funds the Madhya Pradesh model
  could be replicated more widely across other
  states

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Urban Infrastructure Context

• Trends in Urbanization
• Large and medium sized cities growing very fast
  (although overall pace of urbanization is slower
  than might be expected)
• Even faster growth of slum population in these
  cities
• Rising income levels in these cities leading to
  rapid increase in demand for services backed by
  growing ability and willingness to pay
• Trends in Decentralization
• Disconnect between mandate of ULBs and their
  ability to deliver on this mandate growing in
  part as a result of the 74th amendment
• Insufficient decision making autonomy for ULBs in
  part due to jurisdictional confusion and in part
  due to very weak institutional capacity
• No financial autonomy due to very weak fiscal
  base and low credit worthiness
• Overdependence on state governments

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Urban Infrastructure Recommendations

• Introduce a Local Benefit Tax (LBT)
• 1 of sales turnover at the final stage (i.e.
  when registered dealer sells to unregistered
  persons)
• Applicable uniformly across urban and rural areas
  to avoid perverse locational incentives
• No new skills, manpower or rules are necessary
• To be collected by state level Sales Tax
  Departments (through retail invoice) for a fee to
  be paid by local bodies
• Collections to be transferred immediately to ULBs
  (based on origin) and Zilla Parishads (for rural
  areas)
• Increase ULB revenues by 30 and is likely to
  grow annually by an estimated 15-20 and would
  replace inefficient octroi
• Ensure that property tax reform efforts are not
  compromised because of this

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Urban Infrastructure Recommendations

• Ensure that elected and accountable persons are
  given executive power for
• - Use the JNNURM to nudge ULBs in this direction
  ULBs
• Create specialized nodal unit for urban
  infrastructure in every state
• Replicate TNUDF (with appropriate learnings) to
  act as lead agency for JNNURM
• Repository for scarce project development skills
• Facilitate financial engineering for pooled
  financing structures to improve access to capital
  markets

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Power Sector Context

• Power deficit is growing despite policy framework
  
• Capacity not keeping pace with industrial demand
  (shortfalls in public sector targets and
  insufficient capacity addition by private
  players)
• A number of private projects caught in unresolved
  inter-departmental, inter-state, public-private
  conflicts
• Little progress on open access
• Financial situation of SEBs has shown marginal
  improvement
• Not so much because of reduced TD losses, but
  due to growing share of HT consumers
• Payment security still a major constraint to
  financial closure of large projects
• Growing private sector appetite for investment in
  generating capacity
• Based on premise that if you can produce at cost
  lower than median for SEBs, then worth taking
  merchant risk in a market where demand far
  outstrips supply
• Two immediate priorities
• Accelerating the pace of capacity addition
  especially from private sector
• Improving the efficiency of distribution

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Power Sector Suggestions

• Clear framework for privatization of coal mines
  for use in power generation
• Speedy resolution of issues pertaining to gas
  pricing
• Explore incentives for states to allow open
  access
• APDRP scheme should be overhauled such that GoI
  assistance for SEBs is tied to the latter meeting
  time bound targets for open access to HT
  consumers in their respective states
• GoI should insist that the private promoters
  under the proposed Ultra Mega Power Projects be
  allowed to sell a portion of the capacity on an
  unrestricted merchant basis

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Power Sector Suggestions

• Move towards separation of urban from rural
  distribution load stations
• Characteristics of urban and rural electricity
  distribution are very different
• reflecting different client needs, abilities to
  pay, and delivery challenges
• Segregation would make distribution subsidies
  more transparent and better targeted.
• It would also help reduce theft (which is more
  concentrated in urban areas and is partly
  camouflaged in mixed zones through over reporting
  of non-metered subsidized agricultural
  consumption)
• Implementation would have to be state-specific
  and could take different forms (creation of
  separate companies or SBUs or ring-fencing
  arrangements within same company)
• Financial incentives may be needed upfront to
  facilitate segregation, followed by milestone
  based incentives linked to outcomes
• Intense strategic communication would be required
  to convince that segregation does NOT entail a
  pro-urban bias

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Capacity Building for PPPs Context

• A PPP program must be a partnership of equals
  complemented with strong regulatory oversight,
  and effective dispute resolution mechanisms
• Shortage of skills needed to design/develop/manage
  projects suitable for long term contractual
  partnerships with private players, compounded by
  frequent staff rotation -- not all skills can be
  outsourced to consultant
• No institutional mechanism to share lessons and
  reluctance to spend for project preparation
• Regulatory capacity and dispute resolution is
  weak
• Danger of government abdicating its
  responsibilities or of inappropriate allocation
  of risks/responsibilities

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Capacity Building for PPPs Recommendations

• Training and sensitization
• Specialized programs in training institutions
  (IIMs, IEG, NIPFP)
• In house training
• Given the sheer scale of PPP requirements, might
  be worthwhile setting up a dedicated institute
  for the express purpose of training a PPP
  management and regulatory corps
• Create state level PPP units to provide
  hand-holding to various departments
• Assist in inter-departmental coordination
• Act as repository of project development and
  transaction skills
• Disseminate lessons across sectors
• Create a fund that states and central departments
  can access to finance project preparation costs

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Conclusions

• Resource constraints are not insurmountable.
  Immediate challenge is to encourage diversified
  and more effective intermediation of savings such
  that it meets the needs of infra development
  simple measures to facilitate the participation
  of financial investors for equity capital,
  kick-start domestic debt capital markets, and
  improve access to long term foreign debt
  financing would go a long way
• Considerable progress could be made through
  better prioritization of reform initiatives (e.g.
  state highways, inter-modal connectivity) and
  through creative, yet practical, design (e.g. the
  LBT, separation of urban from rural electricity
  distribution).
• The harder problems pertain to pervasive
  institutional deficiencies and the full range of
  governance issues eliminating the
  infrastructure deficit will require us deal with
  these problems head on