India: Challenges Of Financing Infrastructure In India

Last Updated: 1 September 2017
Article by Amit Kapur


I : Context (Defining the Nature of the Beast)

The recent economic survey has on the one hand stressed the need for primacy for public financing of infrastructure development, while noting the slow-down in investments to downsize by 40% the USD 1 trillion target infrastructure investments for the XII Plan (of which 48% was to be private capital). The magnitude of capital required and the shortfall in India is best understood in terms of facts:

(a) 11th Plan's (2007 to 2012) investment target for infrastructure was US$ 500 bn. (Rs.20,56,150 crores) with 30% private investment. Actual private investment rose to 36.87% of the actual investment of Rs.19,00,063 crores.

(b) 12th Plan (2013 to 2017) envisaged an investment target in infrastructure of US$ 1 trillion (Rs. 55,74,000 crores) with 46.68% private investment.

(c) With only 65% of the annual target being met during the first two years, the Plan investment target has been reduced by 40% to Rs.30,93,558 crores with 39.19% private investment.

Certain structural and macroeconomic constraints have caused this slowdown. In fact, as per the recent report from the Central Statistical Office (June 2015), the gross fixed capital formation in India has reduced from 33.6% of GDP in FY 2012 to 28.7% in FY 2015. This translates to a drop by 3.8% in price parity terms. This situation requires resolute action. With structural barriers, delays and institutional hurdles to quick implementation, private investment will be hard to come by. With rising fiscal deficit government would be under pressure to cut down expenditure. This situation, in my view cannot be fixed by innovation in financing instruments or financial engineering. There is a need for structural reforms for any infrastructure investment to be viable and growth oriented.

Economic development results from an inter-play amongst 4 factors of production - (i) labour, (ii) land with natural resources, (iii) capital, and (iv) entrepreneurship. Over the last few decades, the globalized world has seen increased private participation including foreign investment in developing, operating and maintaining infrastructure facilities and utilities. With the challenges of distributive justice in an unequal world, this phenomenon has tested the boundaries of balance between growth, entrepreneurship, social justice and welfare1. This has been particularly discernible in India where a crucial challenge has been the divergence amongst the legislature, the executive and the judiciary in pursuit of the constitutional goals.

For fresh investments in Indian infrastructure to be viable and sustainable in the long run2 there is an emergent need to focus on the eco-system with equitable and vibrant economic development and policies - free of ideologies no longer relevant.

A case in point is the financial stress seen in the power sector where in spite of the overarching structural reforms implemented. India faced a growing creditworthiness crisis in 2001/2002. The system losses were rampant; SEBs had become unviable and defunct since tariffs were uneconomic and subsidies declared were not infused. The accumulated dues owed to Central Public Sector undertakings like NTPC, PGCIL, NHPC, Coal India, Indian Railways etc. had risen to around Rs. 42,500 crores. These dues had to be securitized and financed by Central Government to prevent widespread fiscal problems. That was the context of enactment of the Electricity Act, 2003 accompanied by restructuring of State Electricity Board; uniform regulation distancing Government from tariff determination; and initiating the reform and financial restructuring process through schemes like APDRP, R-APDRP, DRUMS etc.. The gains of the same are significant enhancement of installed generation capacity (272,503 MW in May 2015 against 104,917.5 MW in March 2002; with 56% of this additional 167,586.5 MW coming from private investments. The peak and base load deficits have come down from 12.6% and 7.5% (2002) to 4.7% and 4% (2015). Yet, due to grid constraints, populist interventions in timely revision of economic tariff and fuel crisis, the sector's balance sheet [per unit loss remains static at Rs. 1.10 since 2002] accumulated annual losses has mounted from Rs. 33,177 crores in 2002 to over Rs. 75,000 crores in 2015, such that accumulated losses stand at over Rs. 350,000 crores3.

One of the challenging hurdles is the level of stressed / stranded assets plaguing Indian infrastructure and the Indian financial world is the executive's refusal to address genuine concerns of investors in a time-bound manner while the courts have pursued "puritan justice" at times failing to mould relief to attain the stated policy objectives.

II : Political Economy at play

Shorn of all fineries, a market economy is eventually a web of contracts (both formal and informal) which are constantly being fulfilled or renewed/renegotiated4. Within this web there is an on-going interaction amongst individuals, market, state and society – with issues including public finance, affordability, welfare, life-line supply and viability.

The political economy of infrastructure projects developed in Public Private Partnership mode is defined by the interplay amongst the conflicting stakeholder interests of:

(a) State as a trustee accountable to secure to the citizen reliable and affordable facilities in viable manner, for which purpose when infrastructure development occurs in PPP mode, Government/State is the grantor of licence /concession to build and operate any infrastructure facility which often involve use of natural resources allocated by State.

(b) Investors (public and/or private) who invest equity capital (promoters) and the loan capital (lenders) in the infrastructure facility with an expectation of earning reasonable return to service the capital (dividend and loan repayment).

(c) Suppliers of inputs to produce the infrastructure service/facility who expect to be paid the price of inputs in a timely manner.

(d) Consumers who are desirous of availing of reliable and fairly priced infrastructure facility.

Some noteworthy elements of infrastructure define the political economy and hence must be borne in mind viz. -

(a) Infrastructure assets are created, maintained and operated to provide some "public goods/services5" to the citizen and the economy. Such goods/services are fundamental to a reasonable life and hence are a bounden obligation for the state to secure for the citizen6.

(b) Infrastructure projects involve significant upfront capital investments in creating, expanding or refurbishing the asset which comes at a price (cost of capital). 75% to 85% is debt finance (from banks who lend citizens' savings) available for a tenure between 8 to 15 years only (against an asset life of 30 to 60 years7) to be repaid with interest within this period.

(c) The cost of capital has to be serviced from the tariff / charges levied and recovered from consumers over the project life unless offset by subsidy paid by government from tax-payer funds. Underlying the economics of all infrastructure facilities are duty owed to the consumers of the facility and to the tax-payers. Business principles apply to public utilities as much as they do to commercial ventures. Avoiding losses and inefficiencies culminating in deficit which devolves on public exchequer is important, unless it is paid for (wholly or partly) from public funds.

(d) Invariably all infrastructure facilities involve some concession8 granted by "state" to the operator. Both award of projects, as also performance of utilities (publicly and privately owned) are tested and evaluated in context of the public nature of the facility9.

(e) Infrastructure contracts predominantly are long term arrangements spanning 10-30 years. They are not amenable for writing 'perfect' contracts defining ex-ante the contingencies likely to occur during the lifecycle of an infrastructure project covering all situations and developments during its life-cycle10. Hence the fact that something unforeseen will come up during the 30 to 60 year life cycle of an infrastructure facility is as foreseeable as night follows day!11

(f) Once invested in an infrastructure asset, the key attributes of private capital get significantly regulated / controlled, being:

(i) Investment decision (how much to invest, in what asset and at what location);

(ii) Production decisions (quantity and quality);

(iii) Pricing decision and line-of-credit decisions (whom to sell and on what terms); and

(iv) Return on investment/capital distribution decision.

(g) Being essential facilities with invariably no substitutes, the availability of the infrastructure facility must not be disrupted even if there are disputes during implementation. As such, infrastructure contracts must be a robust framework for:

(i) Allocating roles, responsibilities and foreseeable risks amongst the contracting parties at different phases of design, construction and operation of the project.

(ii) Tackle unforeseen developments which threaten to impair the sustainable operations of the facility12.

III : Some Obvious Elements of Structural Reforms

Based on the past experience, there is a need to evolve the present suite of Model Concession and Bid Documents into a workable template with some guidance and options for project specific adaptation rather than a one-shoe-fit-all approach (prevalent in the UK). A periodic review of the contractual framework for new projects to deal with emerging challenges and ensure optimal utilization of investments made/assets created based on an appropriate feedback mechanism and recommendation on changes with public consultation. The concession framework must be sensitive to the evolving market and the difference in the approach and risk appetite of asset creator and asset operator. Thus, there is a need to ensure that the risk allocation and framework design of the concession is sensitive to these realities.

In addition, it is critical to evolve an appropriate independent institutional framework for PPPs restructuring and dispute resolution drawing upon successful Indian experiences of the regulatory architecture13. While the prospect of restructuring of PPP concession is not desirable but may not always be avoidable14. Any ex-post change in contract terms must  withstand the standards of equity and fairness while securing value-for-money for the stated beneficiaries (citizen) under the given circumstances. For the system to work, it must maintain a high probability of isolating cases which can have a cascading effect on the economy and dealing with them. At time when faced with moral hazard of risk of system collapse, institutions must be empowered to act expeditiously intervene with decisive policy intervention to re-determine some politically unpalatable issues15 like:

(a) What object must the policy choice seek to attain?

(b) Who will not have to pay, and who must bear the burden at times for some others' debt?

(c) Who will not be paid, and who must be paid?

There is a need to adapt existing contractual frameworks for more robust arrangements for new projects to promote durability of concessions and better participation based on:

(a) A fair risk allocation, which also factors the changing risk profile based on the stage of the project (construction vs operation);

(b) Clear roles and responsibilities of the contracting parties;

(c) Well defined mechanism to deal with unforeseen and uncontrollable developments for no fault of parties (including events arising due to Force Majeure, Change in Law, Material Change);

(d) Penal provisions for non-performance; and

(e) Market discovered termination payments and an appropriate take-over provisions.

Based on the Indian experience thus far, need for restructuring in Indian infrastructure has arisen primarily because of:

(a) Macro-economic conditions such as the gas-fired power plants with gas shortages16 and the coal fired power plants with failure of Coal India through-put to keep pace with the demand culminating in drastic reductions in coal linkages under the National Coal Distribution Policy17 as also spiraling in cost of imported coal18, Airport OMDAs19.

(b) Poor concession design which includes improper risk allocation under the contract and aggressive bidding. Renegotiation on account of this reason is prevalent in the road, water and metro sector, e.g., Telecom Migration (1999)20, Dabhol, NHAI Concessions21, Delhi Metro Express Line.

(c) Government action which impacts the implementation or operation of the infrastructure project, thus necessitating the need for reopening of the infrastructure concession. For example, the go-no go decision of Ministry of Environment & Forest, the delays in grant of land acquisition / right of way, environmental clearances to various infrastructure projects.

Clearly identifying the objectives of infrastructure and PPP sector reform would go long way with baseline principles for:

(a) Infrastructure and PPP procurement.

(b) Project implementation and monitoring.

(c) Infra and PPP restructuring and dispute resolution.

It is recommended that an evaluation of the political economy impacting the design and implementation of infrastructure projects in PPP mode be undertaken based on case studies in different industries. Suffice it to say that the same must examine the following elements:-

(a) Selection of projects to be implemented in PPP mode and the criteria including the 'value for money' propositions as also preparedness to factor realistically cost of capital in project design.

(b) Structuring of the role-responsibility-risk compact for the project for diverse stages in the project lifecycle, viz:-

(i) Development and Project Preparation Stage: Pre-bid leading to award.

(ii) Construction Phase culmination in Project Completion and demonstration of Capacity.

(iii) Operations Phase, including significant capacity expansion/ refurbishment stage/s.

(iv) Closure and Decommissioning Phase.

(c) Contract management and performance monitoring mechanism to tackle unforeseen developments and circumstances that destabilize the financial equilibrium warranting timely mid-course correction to secure continued operations in a viable mode.

IV : The Bugbear of Resets/Renegotiation: Unshackle the stranded assets

The key issue is how to design better concession contracts and how to induce both parties to comply with the agreed upon terms of the concession to secure long term sector efficiency and vigorous network expansion. Laws and contracts should permit reopening of the contracts to restore the financial equilibrium of the project only if the project is adversely impacted by uncontrollable factors beyond the control of the parties (i.e. the project or the asset faces hardship on account of uncontrollable factors). Restoration of financial equilibrium should clearly specify the capital base on which the firm is allowed to earn a fair return whilst protecting consumer interest. It must be very clearly stated in the financial equilibrium clause is the period of application as it cannot be for an indefinite period22. Similarly, opportunistic renegotiation should be discouraged in both existing and future concessions.

The key concerns which must be addressed in good renegotiations are:-

(a) How to improve value for all parties (including users), while accounting for all possible fiscal consequences of the contract modification.

(b) How to ensure credibility of the PPP program when renegotiation risks eliminating competition effects of auction and transparency.

(c) Preventing opportunistic renegotiations or outcomes that reward aggressive/irrational bids.

(d) Abuse of asymmetric information and lack of negotiation skills of private sector – with eroding benefits of PPP and welfare of users, with increased liabilities to the Government.

In Political Economy terms, the costs associated with disputes, conflicts and renegotiations are:-

(a) Time and Cost overruns.

(b) All Social and Political Goals – it can erode credibility of PPP model and Government.

(c) Fiscal cost to exchequer.

(d) Economic and Social: Users suffer reduced access, prime impact, delays etc.

The formula for restoration of financial equilibrium should be predicated on the principles which:

(a) Encouraging good performance and optimum investments.

(b) Safeguard consumers' interest.

(c) At the same time, ensures reasonable returns, recovery of the cost of the infrastructure asset/facility in a reasonable manner.

(d) Is premised on principles rewarding efficiency in performance.

An effective and robust renegotiation mechanism must:

(a) Have clearly stipulated approach, criteria, process, jurisdiction and criteria for grant of compensation.

(b) Preserve value for money proposition in PPP contract.

(c) Secure inviolability of contract/bid so far as possible – using financial equation of writing offer as a reference point. All adjustment must have a zero impact on net present value of benefits and risks preserving the risk allocation used sparingly only in deserving conditions – not erroneous tender or aggressive bids.

(d) Use least present value of revenue (LPVR) as bid criteria – robust in initiating renegotiation request by extending contract term.

There is a need to establish a robust institutionalized mechanism based on an effective statutory framework which addresses the following aspects:-

(a) Establish a credible fast-track expert adjudicatory mechanism to provide for renegotiation based on a well-defined framework and process (which can be subject to public scrutiny and test), which:

(i) Safeguard consumer interest ensuring against windfall gains;

(ii) Secure continued operation of the facility;

(iii) Ensure reasonable recovery of the cost of the infrastructure asset/facility in a reasonable manner; and

(iv) Reward efficiency in performance.

(b) Keep the underlying public interest in reliable and affordable infrastructure facilities being available, as also the time value of money, the renegotiation/conflict resolution mechanism ought to be expeditious (time-bound) and cost-effective in its outcomes with involvement of appropriate experts at each stage -

(i) Preliminary decision (say within a month of receipt of reference) to intervene in a PPP project after being satisfied that the situation deserves intervention.

(ii) Guidelines and framework for evaluation of the reference on merits including

(1) Working out the reference limits of the underlying bid/PPP contract.

(2) Computing a prudent value of the adverse impact on the financial equilibrium.

(3) The level of adjustment and the basis for providing the relief to restore the financial equilibrium of the project.

(4) Process whereby such principles are implemented in transparent manner.

In this context, should arbitration mechanism be adapted for conflict resolution/ renegotiation, there is a need to bolster the process and the general approach of courts to interfere with the proceedings and award remain matters of grave concern. It is noteworthy that a new Bill based on 246th Report of the Law Commission of India is under active consideration. In this respect –

(a) The last few attempts to revamp the Indian arbitration process and law since 2003 are yet to see the light of the day.

(b) There is a need to institutionalize arbitration process with a panel of credible experts available as arbitrators, particularly for infrastructure to move out of ad-hocism in arbitration and streamlining the process.

Similarly, should the regulatory institutional mechanism can be adapted for conflict resolution/renegotiation, which benefits from multi-disciplinary expert panels deciding matters in a time-bound manner with adjudicatory powers. It is noteworthy that a draft Regulatory Reform Bill (2013) issued by the Niti Aayog is under public consultation.


 1 Unfinished agenda for Indian democracy in the words of Jean Dreze and Amartya Sen in An Uncertain Glory [Penguin : 2013] is "an imminent need to resolve issues of social and distributive justice (provision of physical and social infrastructure) by constructive use of public resources generated by economic growth to enhance human capabilities". They define the agenda being focused on remedying (i) the continued and exacerbating disparity between the lives of the privileged and the rest, and (ii) persistent ineptitude and unaccountability in how the Indian economy and society are organized.

In their view our democratic politics offers a possibility of change through constructive action [citing social discontent on violence against women (December 2012) and public discourse on corruption, under-nutrition, involuntary displacement (land acquisition), right to education and public sector accountability]. They commend active engagement against virtual exclusion of most of intensely deprived people on political issues - inequalities, stratification and caste-divisions; gender bias; corruption, indignity and exploitation.

2 Whether by attracting more funds from households; by recapitalizing balance sheets of the banks; attracting untapped sources like insurance and pension funds, sovereign funds, et al.

3 Data is based on Planning Commission of India's Annual Report (2001-02) on Working of SEBs (May 2002); Annual Reports of Ministry of Power and CEA website.

4 Adapted from the Paper titled 'The Economy's Mysterious Web of Contracts' by Professor Axel Leijonhufvud (April 2012) presented at Conference held by Institute for New Economic Thinking in Berlin.

5 Like water and electricity supply.

6 This feeds into the citizen's right to access to reliable facilities at affordable prices, as also the universal supply obligations on reasonable terms cast upon the licensee/concessionaire.

7 This mismatch between tenure of the loan and the life of an infrastructure asset results in front-loading of tariff burden on the public utility to discharge the interest and repay the principal.

8 Being a right / privilege to use some public good or facility like spectrum, land/right of way, minerals (coal, oil and gas, iron mines et al)

9 Standards of reasonable and fair conduct expected of instrumentality of state directive principles of state policy warranting maximizing welfare and optimal utilization of scarce natural resources without monopolization.

10 Incomplete contracts have many causes. The first is the inability or costliness of accounting for all possible contingencies in contracts. Agents are not able to describe all the possible contingencies that could affect the functioning of the contract. In such cases writing a clause that includes effort level is useless, because such a clause cannot be enforced. Other contingencies cannot even be foreseen. Finally, writing a contract contingent on all verifiable and foreseeable contingencies may be too costly. Thus parties have to decide which contingencies they want to include.

11 Given that infrastructure assets like airports and power plants can have a lifecycle of 3o to 60 years, the contracts could also be long term ranging from 20 to 40 years. Given the speed at which technology, commerce and economic conditions have changed in the last few decades, what may be a remote or unforeseeable reality today may become an obvious and reasonably foreseeable contingency 10 years later. As such, these may include but are not limited to unforeseen developments like global financial crisis and its implications on trade and finance, force majeure events, changes in law/regulatory regime.

12 Incomplete contracts have many causes. The first is the inability or costliness of accounting for all possible contingencies in contracts. Agents are not able to describe all the possible contingencies that could affect the functioning of the contract. In such cases writing a clause that includes effort level is useless, because such a clause cannot be enforced. Other contingencies cannot even be foreseen. Finally, writing a contract contingent on all verifiable and foreseeable contingencies may be too costly. Thus parties have to decide which contingencies they want to include.

13 In particular, the experience of regulation of electricity, telecom, competition and capital markets are seen as success stories in terms of robustness of expert adjudication and timely disposal.

14 A study covering 1,000 concessions granted in the Latin American and Caribbean region during 1985-2000, found that [30 per cent] of them underwent renegotiations. Renegotiations were especially common in transportation concessions, occurring in 55 percent of concessions, and even more so in water and sanitation concessions, occurring in 74 percent of

concessions. "Granting and Renegotiating Infrastructure Concessions Doing It Right : J.Luis Guasch (WBI Development Studies, 2004)"

15 "The Economy's Mysterious Web of Contracts" by Axel Leijonhufvud (2012), published in the Magazine of International Economic Policy Spring 2012, presented with learnings from the US financial crisis (TARP Program) and the Japanese experience.

16 Recent policy decision of availability of subsidized natural gas for stranded gas based power plants through competitive bidding.

17 Culminating in CCEA and Coal/Power Ministry policy decisions of pass through of price of imported coal for power plants even in cases of competitive bidding.

18 Pending claims for offset of hardship by various plants (Tatas, Adani, GMR, Reliance etc)

19 The approval by the Ministry of Civil Aviation to Delhi International Airport Pvt. Ltd and Mumbai International Pvt. Ltd. to levy an airport development fee on passengers to finance an escalated capital cost by the Airports Economic Regulatory Authority in respect of Delhi International Airport Pvt. Ltd for determination of tariff.

20 The shift from a fixed fee regime to a revenue share model for licensing in the telecommunications sector and for radio broadcasting (NTP-1994 to NTP 1999).

21 Restructuring of payment of premiums and tenure due under NHAI concessions.

22 Only the principles should be specified.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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