GS Notes

6. Economics Notes 22

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Elaborate Notes

Infrastructure Financing: Challenges and Measures

Infrastructure development is a critical prerequisite for the economic growth and development of a nation. However, financing these large-scale, long-gestation projects presents significant challenges.

  • Financial Instruments for Investment: Individuals and institutions can invest in companies, including those in the infrastructure sector, through various financial instruments, each with a distinct risk-return profile.

    • Bonds: These are debt instruments where an investor loans money to an entity (corporate or governmental) which borrows the funds for a defined period at a variable or fixed interest rate. They are considered low-risk as they offer a fixed return (interest/coupon) and repayment of the principal at maturity. They do not require extensive financial knowledge to invest in.
    • Shares (Equity): These represent ownership in a company. They are high-risk because returns (dividends and capital appreciation) are not guaranteed and depend on the company’s performance and market conditions. Consequently, potential returns are also high. Investment in shares requires significant financial knowledge and market analysis.
    • Mutual Funds (MFs): These are professionally managed investment funds that pool money from many investors to purchase a diversified portfolio of securities (stocks, bonds, etc.). The risk is moderate as it is diversified across various assets. Returns are generally lower than direct equity but higher than bonds. They require less financial knowledge from the investor as a professional fund manager is responsible for creating and managing the portfolio.

  • Role of Specialised Institutions:

    • Infrastructure Debt Funds (IDFCs): These are specialised financial vehicles designed to channel long-term debt from sources like insurance and pension funds into infrastructure projects. As per regulatory frameworks established in 2011, IDFCs can be set up either as a Mutual Fund (regulated by the Securities and Exchange Board of India - SEBI) or as a Non-Banking Financial Company (NBFC) (regulated by the Reserve Bank of India - RBI). An important distinction is that units of an IDFC-MF are not permitted to be sold in the secondary market to prevent speculative trading and ensure long-term investment.
    • Banks vs. NBFCs:
      • Deposits: Banks are permitted to accept both demand deposits (like current and savings accounts) and term deposits. NBFCs, if they are deposit-taking (NBFC-D), can only accept term deposits; they cannot accept demand deposits.
      • Reserve Requirements: Banks are mandated by the RBI to maintain a portion of their deposits as the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). NBFCs are not required to maintain CRR and SLR, giving them more liquidity to lend. This distinction was highlighted by several RBI committees, including the Narasimham Committee Reports (1991 and 1998) which discussed financial sector reforms.

  • Key Challenges in Infrastructure Financing in India:

    • Fiscal Burden: The government’s ability to fund infrastructure is constrained by fiscal deficit targets, as mandated by the Fiscal Responsibility and Budget Management (FRBM) Act, 2003. This limits public spending.
    • Asset-Liability Mismatch (ALM): This is a major issue for commercial banks. Banks raise funds through short-to-medium-term deposits but have to lend for long-term infrastructure projects with gestation periods of 15-20 years. This creates a mismatch in the maturity profile of their assets (loans) and liabilities (deposits), exposing them to interest rate and liquidity risks. The Economic Survey of 2014-15 extensively discussed this problem.
    • Underdeveloped Bond Market: Both the corporate and municipal bond markets in India remain shallow and lack liquidity compared to developed economies. This forces over-reliance on bank credit for infrastructure financing.
    • Investment Obligations: Insurance and pension funds are ideal sources for long-term infrastructure finance due to their long-term liabilities. However, stringent regulatory norms by bodies like the Insurance Regulatory and Development Authority (IRDAI) and Pension Fund Regulatory and Development Authority (PFRDA) often restrict their exposure to the infrastructure sector to ensure the safety of policyholder and subscriber funds.
    • Funding Gaps: Global events, such as the Sub-Prime Crisis of 2008, led to a credit crunch globally, which in turn affected the flow of External Commercial Borrowings (ECBs) into India’s infrastructure sector, exacerbating the funding gap.
    • Procedural and Legal Issues: Delays in land acquisition (a challenge the Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013 sought to address), environmental clearances, and contractual disputes lead to stalled projects and cost overruns.
    • Regulatory Cholesterol: This term, popularized by the Economic Survey 2019-20, refers to the excessive and complex web of government regulations, approvals, and compliance requirements that stifle private investment and delay project execution.

  • Government Measures to Address Financing Challenges:

    • Public-Private Partnership (PPP): Post the liberalisation reforms of 1991, and more aggressively since the early 2000s, the government has promoted PPPs to leverage private sector capital, technology, and efficiency. The Vijay Kelkar Committee Report on Revisiting and Revitalising the PPP model (2015) provided a comprehensive framework to re-energise these partnerships.
    • Viability Gap Funding (VGF): Introduced in 2006, this scheme provides a one-time capital grant to make economically essential but financially unviable PPP projects attractive to private investors. The Central Government typically provides up to 20% of the Total Project Cost (TPC), and the sponsoring ministry/state government provides an additional 20%, covering up to 40% of the viability gap.
    • Tax Incentives: The government reduced the withholding tax on interest payments made to foreign lenders for infrastructure debt from 20% to 5%, making it cheaper to raise funds from abroad.
    • Rationalisation of ECBs: The RBI has periodically eased the norms for External Commercial Borrowings, allowing greater access to foreign capital for infrastructure projects.
    • Credit Default Swaps (CDS): Introduced in India in 2011, CDS are financial derivatives that allow lenders to hedge against the risk of default on loans, thereby strengthening the corporate bond market and encouraging lending to the infrastructure sector.
    • Take-out Financing: A mechanism where an institution like India Infrastructure Finance Company Ltd. (IIFCL) takes over the loans of commercial banks after a project becomes operational. This frees up bank capital that was locked in long-term projects, allowing them to lend to new projects and addressing the ALM issue.
    • National Infrastructure Pipeline (NIP): Announced in 2019, the NIP is a massive investment plan of ₹111 lakh crore for over 9,000 projects across various sectors for the period FY 2020-25. Its primary objective is to provide world-class infrastructure and improve the quality of life, forming a key pillar for achieving the $5 trillion economy goal. The NIP data is hosted on the Invest India Grid (IIG) portal, managed by the Department for Promotion of Industry and Internal Trade (DPIIT), Ministry of Commerce and Industry.
    • National Monetisation Pipeline (NMP): Launched in 2021, NMP is a four-year pipeline (FY 2022-25) to unlock value in brownfield (existing) public assets through monetization. It is based on the principle of “Asset Creation through Monetisation,” where revenues generated from leasing out operational assets are used to finance new greenfield (new) infrastructure projects under the NIP.
    • National Logistics Policy (2022): A comprehensive policy aimed at improving the efficiency of the logistics sector. Its key target is to reduce India’s logistics cost from about 13-14% of GDP to a global benchmark of 8% by 2030, through measures like promoting multi-modal logistics parks, cold-chain facilities, and warehouses.
    • PM Gati Shakti - National Master Plan for Multi-modal Connectivity (2021): A digital platform that brings 16 Ministries together for integrated planning and coordinated implementation of infrastructure connectivity projects. It aims to break down inter-ministerial silos and reduce planning and implementation gaps, thereby preventing wastage of public money and time.

Public-Private Partnership (PPP)

PPP is a long-term contractual arrangement between a public agency (government) and a private sector entity for the provision of a public asset or service, in which the private party bears significant risk and management responsibility.

  • Objectives: The primary goals for the government include leveraging private sector finance and efficiency, achieving better value for money, ensuring timely delivery of services, and addressing the large infrastructure deficit.

  • Challenges for PPP projects in India:

    • The Chakravyuh Challenge: A term coined by former Chief Economic Adviser Arvind Subramanian in the Economic Survey 2015-16, this refers to the difficulty of ‘exit’ for failed or stalled projects. Private investors can enter the market (like Abhimanyu entering the Chakravyuh), but find it difficult to exit due to legal hurdles, contractual complexities, and lack of a robust bankruptcy framework, trapping capital.
    • Lack of Easy Exit: This is a component of the Chakravyuh Challenge, where contracts often lack clear provisions for exit or renegotiation, leading to prolonged disputes.
    • Conflict Resolution Issues: Inadequate and time-consuming dispute resolution mechanisms have been a major impediment. The Kelkar Committee (2015) recommended establishing independent tribunals and regulatory bodies to address this.
    • Feasibility Constraints: The PPP model is not a one-size-fits-all solution. It is often not feasible for smaller projects due to high transaction costs or for social sector projects (e.g., rural water supply for BPL families) where cost recovery is difficult.

  • Types of PPP Models:

    • Management or Service Contract: A short-term arrangement (typically 3-5 years) where the public sector retains ownership and overall financial responsibility, while a private firm is paid a fee to manage and operate a specific service or facility. The private partner’s risk is low. Example: Operation and maintenance of a water treatment plant or management of a container terminal at a public port.
    • Turnkey Management Project (Design-Build): This is a traditional procurement model where a private entity is responsible for designing and building a facility for a fixed fee. Upon completion, the responsibility for operation is handed back to the public sector. The private player’s investment and risk are limited to the construction phase.
    • Affirmage / Lease: In these models, a private operator takes on the responsibility for operating and maintaining an existing infrastructure facility.
      • Lease: The private operator (lessee) collects revenue from users and pays a fixed lease fee to the public authority (lessor). The operator bears the commercial risk.
      • Affirmage: The public authority remains responsible for capital investment and retains the commercial risk. The operator collects user fees on behalf of the authority and is paid a fee based on the volume of service delivered (e.g., per cubic meter of water supplied). The key difference lies in the allocation of commercial risk and the revenue-sharing mechanism.
    • Concessions: A long-term arrangement where the government grants a private entity (concessionaire) the right to build, operate, and maintain an asset for a specified period (e.g., 20-30 years). The concessionaire finances the project and recovers the investment through user charges (tolls, fees). Ownership of the asset typically remains with the public sector and is transferred back at the end of the concession period. This model transfers significant risk to the private sector. Example: Many national highway projects built on a Build-Operate-Transfer (BOT) basis are a form of concession.

Prelims Pointers

  • IDFCs (Infrastructure Debt Funds): Can be established as Mutual Funds (regulated by SEBI) or NBFCs (regulated by RBI).
  • Bank vs. NBFC: Banks can accept both Demand and Term Deposits; Deposit-taking NBFCs can only accept Term Deposits. Banks must maintain CRR and SLR; NBFCs are exempt.
  • VGF (Viability Gap Funding): Scheme introduced in 2006 for PPP projects. Central government provides up to 20% of the project cost.
  • Withholding Tax Reduction: Tax on interest payments for infrastructure debt to foreign lenders was reduced from 20% to 5%.
  • Take-out Financing: Mechanism for long-term investors to take over loans from banks, helping banks manage Asset-Liability Mismatch (ALM).
  • NIP (National Infrastructure Pipeline):
    • Investment target: ₹111 lakh crore.
    • Timeline: FY 2020-2025.
    • Hosting Portal: Invest India Grid (IIG).
    • Nodal Agency for Portal: DPIIT, Ministry of Commerce and Industry.
  • NMP (National Monetisation Pipeline):
    • Focus: Monetising existing (brownfield) public assets to fund new (greenfield) infrastructure.
    • Principle: “Asset Creation through Monetisation”.
  • National Logistics Policy (2022):
    • Target: Reduce logistics cost to 8% of GDP by 2030.
  • PM Gati Shakti: A digital platform for integrated and coordinated planning of infrastructure projects among various ministries.
  • Chakravyuh Challenge: Term from Economic Survey 2015-16, refers to the problem of difficult ‘exit’ for investors from projects in the Indian economy.
  • Regulatory Cholesterol: Term from Economic Survey 2019-20, refers to excessive regulations hindering private investment.
  • PPP Model Differences:
    • Lease vs. Affirmage: In a lease, the private operator pays a fixed fee to the government and keeps the revenue (bears commercial risk). In an Affirmage, the government and operator share the revenue (government bears commercial risk).
    • Management Contract: Short-term, low private risk, public sector retains ownership and financial responsibility.
    • Concession: Long-term, high private risk, private entity builds, operates, and often finances the project.

Mains Insights

GS Paper III: Indian Economy & Infrastructure

  1. The Vicious Cycle of Infrastructure Financing:

    • Problem: Over-reliance on bank credit for infrastructure leads to an Asset-Liability Mismatch (ALM) for banks. This increases the risk of Non-Performing Assets (NPAs), especially when projects are stalled.
    • Consequence: A stressed banking sector (the “twin balance sheet problem” mentioned in Economic Survey 2016-17) becomes risk-averse and reduces lending to infrastructure, further slowing down development.
    • Solution & Way Forward: Developing a deep and liquid corporate bond market is crucial to break this cycle. Measures like strengthening credit enhancement mechanisms, rationalizing stamp duty, and developing a robust secondary market are essential. IDFCs and Take-out financing are steps in the right direction but need to be scaled up.

  2. Public-Private Partnership (PPP): A Critical Evaluation:

    • Promise vs. Reality: While PPPs were hailed as a panacea for India’s infrastructure woes, their performance has been mixed. Initial successes were followed by widespread project stalls, contract disputes, and accusations of crony capitalism (“gold plating” of costs, skewed risk allocation).
    • The Kelkar Committee (2015) Perspective: The committee highlighted key issues: imperfect risk allocation (private sector not bearing genuine risks), lack of a robust renegotiation framework, and weak regulatory capacity. It suggested a balanced approach, moving away from a “one-size-fits-all” model and advocating for models like the Hybrid Annuity Model (HAM) for specific sectors.
    • Ethical Dimension (GS-IV): The debate over PPPs often involves a conflict between the private sector’s profit motive and the state’s public service obligation. Ensuring transparency in bidding, fairness in contracts, and accountability for service quality are key ethical imperatives. The risk of “privatizing profits and socializing losses” must be mitigated through robust institutional frameworks.

  3. From NIP to NMP: A Paradigm Shift in Funding:

    • Cause-Effect: The massive funding requirement of the National Infrastructure Pipeline (NIP) of ₹111 lakh crore cannot be met by budgetary resources alone, especially given the FRBM constraints.
    • The NMP Solution: The National Monetisation Pipeline (NMP) represents an innovative approach to financing. It shifts the focus from outright sale of public assets to leveraging operational brownfield assets. The government retains ownership while unlocking their value by leasing them to the private sector.
    • Debate & Criticism: Critics argue that the NMP amounts to leasing out strategic national assets, potentially leading to price hikes for consumers and the creation of private monopolies. The success of the NMP will depend critically on the fairness of the valuation process, the transparency of the bidding mechanism, and the strength of the regulatory oversight to protect public interest.

GS Paper II: Governance

  1. Overcoming ‘Regulatory Cholesterol’ and Silo-based Functioning:
    • The Problem: ‘Regulatory Cholesterol’ and a lack of inter-ministerial coordination have historically been major governance bottlenecks for infrastructure projects, leading to time and cost overruns. A road project could be delayed for months due to pending clearance from the environment ministry or a railway line.
    • PM Gati Shakti as a Governance Reform: Gati Shakti is not just an infrastructure initiative but a significant governance reform. By using technology (GIS mapping, real-time data), it institutionalizes a mechanism for coordinated planning and execution (“whole-of-government” approach). This aims to reduce rework, optimize routes, and ensure faster implementation, thereby improving the ease of doing business and saving public funds.
    • Implications: Successful implementation of Gati Shakti can serve as a model for breaking down silos in other areas of governance, leading to more efficient policy implementation and service delivery.

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