Like governments around the world, India faces an acute need to provide new or modernised infrastructure and public services. Investors evaluate an infrastructure or urban development opportunity in relation to other asset classes such as government bonds, equity markets and private equity. In other words, investors evaluate not just how to invest in infrastructure but whether to invest in it at all.
Many investors, particularly long-term ones such as pension funds, insurance companies and sovereign wealth funds, want to allocate more capital to infrastructure, but struggle to find bankable projects. A significant mismatch exists between the need for infrastructure projects and the capital made available by investors.
Investors assess infrastructure projects against a multitude of options in other asset classes and countries. Naturally, countries with more effective regulatory environments and credible project pipelines will attract more investment at a lower cost.
Fortunately, the most critical policies that interest private finance also tend to benefit society. This underscores a key point: governments can seek private investment while achieving the ultimate goal of creating broader economic value and societal benefit.
In this context, the latest Wold Economic Forum report, titled ‘The Future of Urban Development & Services: Urban Development Recom- mendations for the Government of India’, suggests some specific actions for governments.
Have a strategic vision for infrastructure. A credible vision and clear project pipeline can mitigate investor uncertainty and public scepticism and can trigger productive collaboration between government and investors. Key components in this are:
* Credible project pipeline. Develop an ongoing project pipeline linked to a national vision and strategy to enhance attractiveness. A set of realistic, comprehensive opportunities instead of ad hoc procurements will help investors see value in building capabilities and expertise in India.
* Viable role for investors. Prioritise projects for private sector financing that are most likely to interest investors and achieve value for money for the public. Capital recycling – that is, leasing or selling existing brownfield assets to raise funds for greenfield projects – should be considered.
* Communication strategy. Proactively address the benefits of, and public concerns about, private and possible foreign-investor ownership in infrastructure, particularly by clarifying the difference between “ownership” and “control”.
Create policy and regulatory enablers. A supportive policy and regulatory environment must underpin any strategic vision. Investors frequently cite four main policy impediments:
* Renegotiation risk. The strain on government balance sheets, coupled with several recent high-profile regulatory decisions, has positioned political risk – and specifically renegotiation risk – as a critical concern for many investors.
* Procurement process. Bidding for a PPP project is time-consuming and costly for investors. A lack of standardisation is a major obstacle to an efficient process. A PPP entity should be given the task of enhancing transactional capacity and efficiency on the government side and of driving greater efficiency and standardisation in the procurement process.
* Permitting processes. Regulatory and environmental permitting processes should be reviewed and streamlined, and, if possible, a lead agency should be appointed to manage the process and review of other agencies. Complex permitting processes that lack coordination and predictability will constrain investment in even the most financially attractive projects.
* Tax policy. Tax policy should not systematically give advantage or disadvantage to certain types of investors. Taxes also should be stable over time. The holistic impact of all forms of taxation should be assessed based on the financial viability of projects.
Develop an investor value proposition. Investors evaluate the risk-return of an infrastructure opportunity in relation to investments in other asset classes and jurisdictions. To develop a strong investor value proposition at the level of an individual project, the government should address three crucial issues:
* Financial returns from the investor perspective. Projects should be analy-sed from an investor’s perspective to determine financial viability, support risk-allocation decisions and benchmark risk-return compared with other investment opportunities. The government should not expect investors to accept a lower return simply because a project has significant social benefit. Many investors are restricted by fiduciary duties and legislation to maximise risk-adjusted returns.
* Risk allocation. The government should develop a standard methodology for allocating risk–a set of “guiding principles” to determine the level of risk allocation optimal to both deliver value for money and provide investors with an appropriate risk-return. In the current environment, the allocation of financing risk and demand risk is crucial. To manage financing risk, the government could consider alternative approaches to incentivising transactions, such as credit guarantees. For demand uncertainty, risk-mitigation options could include availability-based payments and risk sharing.
* Market sounding. Market sounding with potential investors should be interactive and undertaken early to generate feedback on a project, learn more about investor preferences and determine refinements needed prior to the tender process.
Once the policy environment is stable and the right conditions for investors have been created, the government needs to look at the various tools available to foster investment in strategic infrastructure and urban development. One such tool is PPPs, with which the government already has experiences.
PPPs can accelerate infrastructure development by tapping the private sector’s financial resources as well as its skills in delivering infrastructure effectively and efficiently on a whole life-cycle-cost basis. But despite this supposed fit between demand for and supply of private sector participation, too few projects have been successful in India.
The reason for this paradox is the “project preparation gap,” that is, the lack of well-prepared, bankable PPP projects where investors are sufficiently reassured by the commercial and technical feasibility, the risk allocation and the public sector’s contractual commitment and capacity, as well as by the institutional and legal framework.
Furthermore, of the PPPs that have been implemented, several have been plagued by delays, cost overruns or re-negotiations as a result of a suboptimal preparatory phase.
As an immediate step, the government of India start by reviewing and benchmarking its PPP policies and frameworks against the global best practices to identify areas most relevant to India. Based on these insights, it should aim to standardise its PPP approach to align with best practices, for example, by establishing a clear gateway/ approval process; by institutionalising project-preparation facilities, viability-gap funding or financing/guarantee facilities; and by providing model documents for contracts and requests for proposals/quotations (RfPs/RfQs).
To maximise the value of PPPs, the government should structure them as long-term programmes within a national infrastructure plan and a national spatial strategy, instead of as a series of separate projects.
The government should keep its expectations flexible and realistic by also looking beyond PPPs: the PPP approach to infrastructure and urban development projects in India is no fail-safe silver-bullet solution and, if a PPP does not deliver the best value for money, it should be abandoned and perhaps replaced by a more suitable delivery mode.
PPPs are an option, not an objective. But overall, a well-designed PPP strategy and programme—complemented by other policies to improve infrastructure and urban development prioritisation, delivery and operations—will provide India with a great opportunity to boost its infrastructure, increase economic competitiveness and achieve major socioeconomic advances, says the WEF report.