The mid-term appraisal of the 11th Five Year Plan, as well as Tuesday?s conference on infrastructure organised by the Planning Commission, point to how serious the current government is about building infrastructure. In spite of the global meltdown bringing about a temporary drought of financing during the first half of the Plan, the revised estimates for the overall infrastructure investment are virtually unchanged from the initial projections (down by 0.1%). This is 127% and 136% higher than the actual investment and original projections in the 10th Plan, respectively.
But the consistency of the overall figure may be misleading. Infrastructure is an omnibus term. There are important readjustments among the sectors. For instance, the revised projection for roads is down by 11%, railways by 23% and ports by 54%. The stability in overall figures is maintained by overachievement in telecom (revised estimates up by 34%) and a whopping increase in oil and gas pipelines (up by 655%) simply by including oil pipelines in infrastructure. So, concerns persist at the sector-level. In particular, transportation continues to constrain growth and needs much greater investment.
A major change has also occurred on the public-private sharing of investment. Originally, the 11th Plan sought to raise the share of private investment in infrastructure from 20% at the end of the 10th Plan to 30%. The revised break-up further ups the share of private sector to 36%.
Problems and bottlenecks remain in the financing side though. Infrastructure financing in general is long-term in nature with very long payback periods. Therefore, institutions like pension funds and insurance companies with long horizons are the natural suppliers of funds for infrastructure projects. Also, shorter horizon players like banks should have instruments that impart liquidity in their investments in infrastructure projects so that they can come out of those investments, if they need to, before the project itself gets over. On both counts, the Indian financial system does not fare too well. According to the initial projections of the 11th Plan, banks accounted for more than half of the debt financing for which a source was identified. Pension funds and insurance companies came in at a mere 7%. In practice, too, banks currently finance about 45% of the infrastructure funding of the country. That is clearly a sub-optimal arrangement. The bank dominance in funding reduces the length of time for funds available to private sector projects to around 12 years, which is considerably shorter than what the project promoters would like.
A solution to many of these problems may lie in the development of the corporate bond markets in India. This is one area where the recognition of the problem is unanimous and the criticality of the market is widely acknowledged. And yet, after years of regulatory attention?with concerted efforts beginning at least from Chidambaram?s acceptance of the Patil Committee recommendations years ago?progress has been sluggish. Corporate bonds in India have a negligible secondary market and issuers would much rather raise debt through private placements rather than make public issue of bonds. There seems to be a chicken-and-egg problem here with both the issuers and potential buyers avoiding the market, while blaming each other for the lack of instruments and liquidity. Another party pooper frequently pointed out is that pension funds and insurance companies, once again the natural home of corporate bonds, are not allowed to hold bonds of anything but top credit quality. None of these have easy solutions that do not compromise other parts of the system.
It is in this setting that one must view the current government?s proposal to extend tax-exempt status to infrastructure bonds issued by private companies. It has the potential of achieving the twin objectives of making funding available to private infrastructure projects and breathing life into the dormant corporate debt market in India. If it works, it can go a long way in not just easing life for the current infra catch-up exercise?one of the most ambitious in the world?but also in helping create an institution to fill a void in the financial structure of India.
There are, of course, questions. Is this subsidisation by stealth? In a sense, but the revenue loss is transparent enough. Would it not divert funds from other purposes? Sure, that?s the whole point; infrastructure is top priority. Would this not give the rich undeserved tax breaks? Maybe, but that is the same question as government subsidy since the exchequer loses out. Can the government select sectors? Will it be arbitrary? That depends on the implementation.
On the whole, it looks like a good idea with limited side effects. The biggest question, however, is: will it work? Unfortunately, the answer there is less certain: we will never know until we try.
The author teaches finance at the Indian School of Business, Hyderabad