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PRESENTATION AT THE ICRIER SILVER JUBILEE SEMINAR

Rajiv B. LallMD & CEO, IDFC

NEW DELHINovember 6, 2006

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GOVERNANCE IS KEY

Governance is the fundamental theme that cuts across all aspects and segments of infra development challenge

Inter Departmental Issues

Centre State Tension

Rural Urban Divide

Public Private Competition

Infra development is especially vulnerable to conflicts and tensions in these four dimensions -- their resolution is all about governance

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Governance must improve to meet the new challenge…

Our ability to implement reforms, and indeed our choice of reform options is constrained by the reality of our political economy and the quality of our governance

Theoretical, first best solutions are a useful beacon, but reform initiatives must be designed and sequenced taking due account of the realities of political economy

However, it is not possible beyond a point to design measures that skirt around poor governance. The bottom line is that we will not be able to meet the challenge of infrastructure development unless we tackle governance

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The infrastructure agenda

Finance

Roads and ports

Urban

Power

Capacity building

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Infrastructure Financing: Context

Infra spend (GFCF):2005/06

% of GDP USD

2010/11% of GDP USD

Central Govt 0.5% 4b

1.0% 12b

Central PSUs 2.1% 17b

3.0% 35b

State Govts & their enterprises

1.0% 8b

1.0% 12b

Private Sector 0.9% 7b

2.5% 30b

Total o/w Financed through:

4.5% 36b

USD 350b over 5 yrs

7.5% 90b

Govt Bonds 1.7% 14b

2.0% 24b

Domestic credito/w from Banks

1.5% 12b0.8% 6b

3.0% 36b1.2% 12b

Pvt. domestic equity finance 0.3% 2b

1.0% 12b

Internal accruals 1.0% 8b

1.5% 18b

Domestic Savings/GDP 30% 34%

Financial Savings/GDP 15% 19%

Infra spend/Financial Savings

30% 37.5%

39%

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Infrastructure Finance: Context

Domestic savings seem tight although the constraint is not insurmountable Foreign savings (current account deficit) of about 2% should be enough to sustain

a higher investment ratio, provided domestic savings effort improves through demographics and FRBM

Overall savings effort may not be a challenge, but intermediation will be Priority to foreign equity capital -- will need 0.5 percent of GDP per year In addition targeted access to long term debt finance from overseas would help

May not be possible/ desirable for domestic banks to finance growing share of infra financing needs: need for other channels of intermediation In our base case, infrastructure’s share in incremental bank credit would have to

more than double from 8% to over 36% => exposure limits? Banks will be equity constrained (especially after Basle II) to fund non recourse

loans ALM (duration) mismatches will make banks vulnerable to interest rate risk

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Infrastructure Finance: Recommendations

Encouragement to domestic and foreign financial investors for equity capital Allow insurance companies and PFs to invest in funds and/or SPVs owning

infrastructure assets (relax requirement of dividend history for such investments) Allow minimum funds under management as eligibility criterion instead of net

worth for financial investors bidding for infra assets

Implement recommendations of Patil Committee on debt capital markets especially with respect to development of market for securitized assets Allow insurance companies, PFs and IIFCL to buy investment grade securities of

long term infrastructure focused CLOs and CDOs Allow FIIs to buy tranches of long term infrastructure focused CLOs and CDOs

Encouragement to infrastructure focused NBFCs Allow these NBFCs automatic access to ECBs at least from multilaterals and

reputed regional financial institutions Allow insurance companies, PFs, and IIFCL to invest in long term investment grade

bonds issued by these NBFCs

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Road and Ports Sector: Context

First generation initiatives reasonably successful GQL in roads, privatization of berths in major ports, development of

private minor ports

Next generation of challenges: Central government institutions unprepared for scale of PPP engagement

needed in the sector Confusion between role of government as policy maker, regulator and

operator State level focus/resource allocation to road/port development very

patchy Inter-modal connectivity and competition issues have been neglected

with risk of new bottlenecks 124,300 km of State Highways constitute 4% of road network and carry

40% of traffic (similar to NH traffic share) are grossly under funded

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Road and Ports Sector: Recommendations

Focus MoSRTH on policy making framework; allow NHAI and Port Trusts greater autonomy and clear responsibility and accountability for execution Training and infusion of professional expertise in PPP management and

project development for NHAI and Port Trusts is critical Strengthen legal provisions with respect to ability of NHAI and Port

Trusts to contract independently with private concessionaires – the National Highways Act, NHAI Act, Indian Ports Act, Major Ports Act

Create strong and independent dispute resolution capacity

Formulate national integrated transport policy framework Create inter-ministerial (roads, ports, rail and airports) forum/group to

develop and review inter-modal transport policy blueprint on regular basis

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Road and Ports Sector: Recommendations

Focus on State Highway development Central government can play a more active role in steering state level

road development and formulating a common framework- Would reduce states’ time and efforts to initiate a medium term investment program.- To include models for road development policy, state highway act and road funding.

All states to prepare a road data base and master plan for road development and maintenance by all states

Create state highway authorities with modern management systems and set up state level dedicated road funds – the Madhya Pradesh model could be replicated more widely across other states

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Urban Infrastructure: Context

Trends in Urbanization Large and medium sized cities growing very fast (although overall pace of

urbanization is slower than might be expected) Even faster growth of slum population in these cities Rising income levels in these cities leading to rapid increase in demand

for services backed by growing ability and willingness to pay

Trends in Decentralization Disconnect between mandate of ULBs and their ability to deliver on this

mandate growing in part as a result of the 74th amendment Insufficient decision making autonomy for ULBs in part due to

jurisdictional confusion and in part due to very weak institutional capacity No financial autonomy due to very weak fiscal base and low credit

worthiness Overdependence on state governments

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Urban Infrastructure: Recommendations

Introduce a Local Benefit Tax (LBT) 1% of sales turnover at the final stage (i.e. when registered dealer sells

to unregistered persons) Applicable uniformly across urban and rural areas to avoid perverse

locational incentives No new skills, manpower or rules are necessary To be collected by state level Sales Tax Departments (through retail

invoice) for a fee to be paid by local bodies Collections to be transferred immediately to ULBs (based on origin) and

Zilla Parishads (for rural areas) Increase ULB revenues by 30% and is likely to grow annually by an

estimated 15-20% and would replace inefficient octroi Ensure that property tax reform efforts are not compromised because of

this

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Urban Infrastructure: Recommendations

Ensure that elected and accountable persons are given executive power for- Use the JNNURM to nudge ULBs in this direction ULBs

Create specialized nodal unit for urban infrastructure in every state Replicate TNUDF (with appropriate learnings) to act as lead agency for

JNNURM Repository for scarce project development skills Facilitate financial engineering for pooled financing structures to improve

access to capital markets

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Power Sector: Context

Power deficit is growing despite policy framework Capacity not keeping pace with industrial demand (shortfalls in public sector

targets and insufficient capacity addition by private players) A number of private projects caught in unresolved inter-departmental, inter-state,

public-private conflicts Little progress on open access

Financial situation of SEBs has shown marginal improvement Not so much because of reduced T&D losses, but due to growing share of HT

consumers Payment security still a major constraint to financial closure of large projects

Growing private sector appetite for investment in generating capacity Based on premise that if you can produce at cost lower than median for SEBs, then

worth taking merchant risk in a market where demand far outstrips supply

Two immediate priorities: Accelerating the pace of capacity addition especially from private sector Improving the efficiency of distribution

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Power Sector: Suggestions

Clear framework for privatization of coal mines for use in power generation

Speedy resolution of issues pertaining to gas pricing

Explore incentives for states to allow open access APDRP scheme should be overhauled such that GoI assistance for SEBs is

tied to the latter meeting time bound targets for open access to HT consumers in their respective states

GoI should insist that the private promoters under the proposed Ultra Mega Power Projects be allowed to sell a portion of the capacity on an unrestricted merchant basis

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Power Sector: Suggestions

Move towards separation of urban from rural distribution load stations Characteristics of urban and rural electricity distribution are very different

reflecting different client needs, abilities to pay, and delivery challenges Segregation would make distribution subsidies more transparent and

better targeted. It would also help reduce theft (which is more concentrated in urban areas

and is partly camouflaged in mixed zones through over reporting of non-metered subsidized agricultural consumption)

Implementation would have to be state-specific and could take different forms (creation of separate companies or SBUs or ring-fencing arrangements within same company)

Financial incentives may be needed upfront to facilitate segregation, followed by milestone based incentives linked to outcomes

Intense strategic communication would be required to convince that segregation does NOT entail a pro-urban bias

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Capacity Building for PPPs: Context

A PPP program must be a partnership of equals complemented with strong regulatory oversight, and effective dispute resolution mechanisms

Shortage of skills needed to design/develop/manage projects suitable for long term contractual partnerships with private players, compounded by frequent staff rotation -- not all skills can be outsourced to consultant

No institutional mechanism to share lessons and reluctance to spend for project preparation

Regulatory capacity and dispute resolution is weak

Danger of government abdicating its responsibilities or of inappropriate allocation of risks/responsibilities

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Capacity Building for PPPs: Recommendations

Training and sensitization Specialized programs in training institutions (IIMs, IEG, NIPFP) In house training Given the sheer scale of PPP requirements, might be worthwhile setting

up a dedicated institute for the express purpose of training a PPP management and regulatory corps

Create state level PPP units to provide hand-holding to various departments Assist in inter-departmental coordination Act as repository of project development and transaction skills Disseminate lessons across sectors

Create a fund that states and central departments can access to finance project preparation costs

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Conclusions

Resource constraints are not insurmountable. Immediate challenge is to encourage diversified and more effective intermediation of savings such that it meets the needs of infra development – simple measures to facilitate the participation of financial investors for equity capital, kick-start domestic debt capital markets, and improve access to long term foreign debt financing would go a long way

Considerable progress could be made through better prioritization of reform initiatives (e.g. state highways, inter-modal connectivity); and through creative, yet practical, design (e.g. the LBT, separation of urban from rural electricity distribution).

The harder problems pertain to pervasive institutional deficiencies and the full range of governance issues – eliminating the infrastructure deficit will require us deal with these problems head on