The slowing down of growth to an estimated 6.4 percent for the current year was largely attributed to falling gross capital investment, not so much consumption which seemed to be intact. Expectations from the Budget therefore could be around sops to incentivise investment.
For some years now, capital formation has been driven by the household and government sectors (including the public sector), with private sector investment erratic and sluggish. Government capex has largely been on infrastructure, mainly roads and railways, while household investment was primarily in real estate.
Weak private sector interest
Private investment has been sluggish in manufacturing ostensibly due to excess capacities and insufficient domestic demand but no such constraints exist in infrastructure where there is a huge unmet demand.
Another interesting aspect of private investment has been its changing composition- plant and machinery which was over half of all investment a decade ago, has been declining and intangible assets now account for over a fifth of investment, implying either lower capital intensity or simply the nature of modern businesses.
But private investment in infrastructure has also been lacklustre. Barring the initial spurt in the heyday of PPP during 2010-14 when many projects in roads and power sector flooded the scene, investment has been declining.
Infrastructure projects would have been traditionally financed by development finance institutions such as IDBI and ICICI. But after their exit in the late 1990s, banks took up the baton with not-so-happy outcomes for them and the private investors.
Banks have burnt their fingers
Banks’ exposure to the sector had shot up to 14 percent by 2014, with lending to road and power projects alone growing by 30 percent on average. Banks learnt at great cost that these long gestation projects with back-ended cash flows were unsuited for bank financing, which sourced through short-term liabilities. Private sector investors also burnt their fingers with PPP as they found themselves saddled with project risks (delays in clearance, fuel linkages) and impaired project viability as revenues failed to match estimations. Not surprisingly, bank NPAs mounted and the share of infrastructure in total stressed advances of banks climbed to 30 percent by March 2014.
‘NIP’ falls short of expectations
Given the poor experience with PPP, the challenge for the Government will be to make them attractive again. This is maybe what the National Infrastructure Pipeline (‘NIP’) launched in 2020 set out to do. It had an ambitious target of an annual investment of Rs 22 lakh crore over five years but actual investments fell much short as government capex averaged around Rs 13 lakh crore in the last four years. Besides, the PPP model did not find many takers with only a fifth of the identified 9,666 projects coming under PPP. The pipeline also revealed a massive skew in projects- they were concentrated in roads and power, maybe because these had the most shovel-ready projects. This left critical sectors such as urban infrastructure (water supply, sewerage systems, rapid transport system) languishing.
The alternate Hybrid Annuity Model (HAM), pitched as a solution to the twin problem of finance and risk sharing led to debt burgeoning for Government agencies such as the NHAI, as it envisaged Government financing 40 percent of the project and taking up the responsibility of toll collections. This also went against the essence of private participation.
Pricing public infrastructure to make investment attractive to investors without impairing public affordability had always been a challenge. Even if PPP models could somehow be redesigned to address the issues of viability and risk, the financing problem is still huge. Banks have already pared their exposure to the sector and with their earlier experience, they are unlikely to take on further risk, given their asset-liability mismatch issues.
As in other countries, a deep and vibrant bond market will be the best bet for infrastructure. But the reasons for its absence are well known, the principal problem being Government’s large fiscal deficit which pre-empts a huge part of the long-term savings in the economy. As much as 40 percent of bank deposits, pensions, small savings and insurance have been locked up in financing the Government.
Specialised institutions may be the key
There were also initiatives to revive the DFI model with the setting up of IIFCL in 2006 and the NABFID in 2022. But their loan books are still modest (Rs. 51,000 crore and Rs 35,000 crore respectively). To be fair, they are lending long and have access to long term funds, but their dependence on tax-free bonds and bank subscriptions could make their long-term sustainability fragile. Moreover, the project skew continues with these institutions also heavily focused on roads and power projects.
With roads, railways and power sectors getting sufficient attention, it may be time to consider sector-specific initiatives say, for urban infrastructure. Municipal bonds and local body finances among others are the areas that need reforms. Municipal bonds are the universal way to tap money for urban infrastructure, but in India, they have not taken off with only a paltry Rs 2600 crore raised by 11 municipal corporations thus far, as compared to the $ 4 trillion market in the US. The poor financials of municipal bodies, low liquidity of the bonds and the lack of investment space in PFs, insurance and pension funds among others, have made them a non-starter. Perhaps setting up specialised intermediating institutions, on the model of the TNUDF in Tamil Nadu, could help as most municipal bodies neither have the financials nor the capacity to raise money or execute projects on their own.
