Rebuild India’s Infrastructure & Finance it with FDI & Export Earnings

Rebuild India’s Infrastructure & Finance it with FDI & Export Earnings

by Hari Sud

Has India’s infrastructure crumbled that it no longer can cope up with growing economic needs? The business investors from abroad often pose this question.

No is the answer to the first part of the above question. India’s infrastructure is alive and well and is adequate to the previously slow growing economy. Yes is the answer to the second part of the above question where accelerated growth of the last five years has made the existing infrastructure completely inadequate. It is no secret that this infrastructure needs to be rebuilt to a level where western investor is comfortable when he invests his money in India. Various estimates have been published from $150 billion to $330 billion required over next 5 to 10 years to rebuild power plants, roads, railways, ports, airports, water works, health care, education, upgrade city services etc. This tall order is outside government’s capability to finance, let alone building it and successfully running it. Private finance and their co-operation are needed to push India into the twenty first century. Without it, outside investor will have less confidence in India and would probably look elsewhere to get a good return on his investment.

What Does India Spends on Infrastructure Today?

Current infrastructure expenditures estimates at about $21 billion a year in last two years is extremely low. Fiscal year 2006-07 is the first year in which greater emphasis has been placed on rebuilding the infrastructure. It is estimated that about $49 billion will be spent in the current fiscal year; increasing to about $80 Billion a year by 2008-09, only if funds needed, becomes available. The forgoing is a huge jump and should put skepticism at ease. About 60% of this expenditure will be on improving the existing services; balance in capital expenditures on new building program. Both of these expenditures will modernize and upgrade the present system. The capital sum of about $20 to $30 billion is totally inadequate, especially if the nation has to consistently achieve 10% growth rate. Capital sums requirements for a world-class system in India have been variously estimated at about $40 to $50 billion a year. This additional requirement has sent India’s political establishment scurrying for favors abroad. Investors are being wooed. Technical help to modernize the system is being sort. Only when some of the above is in place, the investors abroad will have confidence in ‘New India’ and then they will have no excuse to look for another place like China to invest.

China’s infrastructure was in worse shape in 1982 than that of India’s at that time. But they began building program soon there after. Whereas the foreign investors concentrated their funds on building factories, China used its own funds and export earnings to build the infrastructure. From 1982 to 2003, it is estimated that the capital spending of about $300 billion went into it. Today, it is estimated that China spends close to $150 billion on infrastructure including capital sum. Discounting a few double accounted items from the total, their expenditure is four time than that of India. Their capital-spending program has transformed cities like Shanghai Beijing and first-rate transportation system etc. These cities look like any western city. Chinese have an eye on positive publicity it will generate, hence concentrate their energies on where it will be most beneficial. Elsewhere in the hinterland, it is middle-ages transportation system.

Where Does India has to acquire Funds for this Building Program?

Three are only three ways to get money to build the infrastructure in India, namely:

1. Use the huge pile of foreign exchange reserves.
2. Use FDI as source of cash and foreign technical know how with their participation.
3. Borrow from open market and pay it off with export earnings.


Use the Foreign Cash Reserves

This method is the most talked about and least likely possible to get the needed cash. A foreign reserve at about $160 billion, (held in US and Europe) is needed, should a cash flow crisis strike again in early nineties negligible foreign reserves resulted in India, mortgaging its gold in lieu of loans to finance imports. It was the worst financial crisis in modern India. It cannot be allowed to repeat. Hence foreign reserves have to be left alone. In addition India’s has about $130 billion debt, which it owes to foreign lending institutions. To this if we add funds already committed and not yet paid, it roughly balances the cash reserves. Hence the cash reserves become a sort of security to the lenders. The lenders will never move against these reserves and seize them, except in case of war or complete refusal to pay back debt, which is unlikely.

The above is not an unusual situation. China has about $800 billion in reserves and about the same amount in FDI loans. Their cash reserves are held against the FDI invested in the country.

Still, foreign reserves in small amounts can be used to finance the infrastructure build. Funds of the order of $40 to$50 Billion a year has to be financed through other means.
FDI & Foreign Participation

This financing method is most likely to yield good results. There is a mountain of cash available in the world financial markets, some of which is awaiting Indian government signal to flood in. A few rules and policy changes have to be made before the floodgate is open. This money will also bring with it foreign participation, which is sorely needed for this very complex and highly technical sector. FDI has transformed China. It will do the same to India. The question is ‘what is the delay’. The first and foremost is to understand bureaucratically how to manage the FDI in the infrastructure sector and how to pay it back with export earnings. Second is how to avoid future Enron type fiascos. The latter had ten years of shameful delay and cost escalation in the construction of much needed power plant. Nuclear power plants, which require imported technology and Uranium will most certainly require FDI in big amounts. With the passage of Indo-US nuclear deal, funds needed to build 8 nuclear power plants will arrive without much hype. Modernization of transport sector, another area lagging far behind, is to be undertaken in earnest. It also requires foreign money and their technical expertise.
Borrow Money in Open Market

Yes, this is the most talked about way to finance infrastructure projects. It is not the best. About $300 billion borrowed will add to the debt burden of the nation. Even if it is to be paid with export earnings, success of all export projects is not guaranteed. Political interference will create new Enrons. These will drag down export earnings and make debt servicing a major problem.

Technical and management expertise will have to be obtained together with the import of equipment and machinery. The ideal would be far the governments to manage these projects and hope to run them smoothly, that will be first for the nation. Most of government run power plants & power distribution, steel mills, roads and railways have not lived up to the national expectations. Even if private sector partners with the government or participate independently in projects, political interference in one form or other will reduce project profitability. This will all result in reduced export earnings and inability to pay off debt. The latter will create a whole set of new problems, very much similar to financial crisis which Argentina; Mexico, Brazil had in the past 20 years and all the Asian Tiger nations went through in the late nineties. They all borrowed too much and invested in projects with none or very little return. IMF bailed them out every time but at a high cost to the people.

Hence there is no single perfect way to finance major infrastructure upgrade. A combination of all the above three is the best possible solution. The only nation, which has successfully implemented infrastructure upgrade is China. They are to be studied and copied.

Encourage the Private Sector to take up the Bulk of the Upgrade Projects

Overall investment plan for this sector is being drawn up by the government’s planning body. It includes participation of central & state governments together with the private sector. The latter is expected to fund and manage about 20% of the overall investment and projects. To achieve this, a few regulatory problems and lack of transparency have to be tackled. Power sector is one of the most critical components of infrastructure development. It drives all other sectors forward. 1990 is the watershed year in this area. Prior to that private participation in power sector was limited. Enron’s Dhabol Power Plant was one of the first major project, but failed to inspire confidence due to many reasons. This discouraged foreign interest in India’s power sector. Thanks to the political party in power today that this power plant will generate power for the power hungry state. In addition, foreign interest in India’s power sector has picked up. The GE has big plans for India.

Today, private interests generate about 11% of the total power. State and central interests generate the rest. Private sector participation is meager. If this sector has to reach an optimum capacity, then private sector has to come forward with an iron will and wrist of steel to overcome all problems. Indo-US nuclear deal will help. It will have foreign private participation in it. But the first nuclear power plant under this deal will not be operational until about 2012. Until then all possible avenues to add additional power capacity are to be explored. Natural gas from Iran may help, but current international climate make dealing with Iranians impossible. Here again first gas power plant with Iranian Gas, if the gas ever arrives, may not become operational until 2011. Under the circumstances, nuclear is better option.

Privatization of Delhi and Mumbai airports has already given a shot in the arm both for the transportation sector as well as to the privatization. Others projects will follow soon. An eight-lane highway is being built by the private sector to link Bangalore to Chennai. Success of this venture has already spurred interest in projects elsewhere.

Hence groundwork for private participation has already been laid. It is making a steady progress. Soon it will become one of the major players in this sector.

In short India has lately recognized that without proper infrastructure there is no possibility of making rapid strides on the economic front. Hence special emphasis has to be placed on it. All plans boil down to one simple issue i.e. who will pay for it and will the investment have an adequate return to justify more investment? That issue is to be sorted out first to everybody’s satisfaction. A variety of instruments exist to finance it. A combination of some of these instruments will have to be used to achieve the goal.