Plugging Asia’s yawning infrastructure gap
Governments, with the assistance of MDBs, need to take the lead to crowd in long-term private capital by making infrastructure a more viable asset class
The third annual Asian Infrastructure Investment Bank (AIIB) summit was held in Mumbai on 25-26 June.
In a span of three years, the AIIB has done a commendable job, with the value of approved projects being around $4.4 billion, one-third of which have been granted to India alone. However, Asia’s infrastructure deficit is much more formidable than what the AIIB or other multilateral development banks (MDBs), together, can finance.
Despite the fanfare associated with public-private partnerships and the vast pool of potentially investible “patient” capital, the response of the private sector has been largely disappointing to date. Governments in India and elsewhere have had to rethink the options available to them to close the infrastructure deficit.
Enhancing fiscal space
Despite various technological and financing innovations, government support will remain critical in the infrastructure sector. Thus, it is imperative that governments enhance fiscal space in conventional ways, such as broadening the tax base without blunting supply side incentives, enhancing tax administration efficiency, reducing tax loopholes, and streamlining revenue expenditures. Increasingly, there is recognition that governments must rely on user charges as an additional source of revenue.
A relatively more innovative option is to engage in asset recycling, which involves monetizing publicly-funded, commercially viable and operational projects. This allows governments to modernize existing infrastructure, while at the same time unlocking the capital stuck in mature infrastructure assets that are operational and earning revenues. In India, the National Highways Authority (NHAI) has undertaken its own version of asset recycling through the toll-operate-transfer (TOT) model, wherein the government leases out the already built and operational highways to private companies for operation for 30 years and sometimes offers toll risk guarantees.
The success of the TOT to date suggests that this could be a viable option moving forward, across states and other sectors, provided the government offers clarity on pricing and governance issues relating to how the funds are utilized (i.e. clear ring-fencing of funds as in the case of NHAI). Another option is to “capture” land value where governments secure some of the upside in property values resulting from building a new piece of infrastructure, which is used to help fund the project. This can be done through developer charges, betterment levies, property transaction taxes or even land taxes. The experiences of Hong Kong and Singapore offer useful insights.
Reducing project risks and costs
While garnering resources to plug the infrastructure gap is important, there is a limit to how much governments can do on their own. Given the long gestation period and high sunk costs often required for projects, it becomes vital to reduce PPP project risks by raising their “bankability”.
Stalled projects are a pressing cause for concern in India owing to a host of issues connected with regulatory uncertainty, difficulties in land acquisition and environmental concerns, and developer bankruptcies, among others. The Indian government’s establishment of the National Investment and Infrastructure Fund (NIIF) to extend last-mile funding to stalled projects and solicit private sector participation is also an interesting experiment.
In another financing model, the NHAI has tried to alleviate some of these risks and the huge capital expenditures required by offering a hybrid annuity model (HAM), whereby the government pays the developer 40% of the project cost and collects tolls, while the developers are given annual payments over a predetermined period.
Considering that infrastructure assets face different risk-return characteristics based on their life cycle, one way to reduce project risks and lower the cost of capital is for the government to implement credit enhancement schemes. This can be done via several avenues.
First, the government could help raise the credit rating of bonds floated by infrastructure companies and facilitate investments from long-term investors.
Second, governments could consider using foreign exchange reserves to lower the financing costs, as in the case of Singapore where the government is considering providing guarantees for some long-term borrowings for critical national infrastructure by tapping its reserves.
Third, risks could be spread through securitization by allowing the creation of investment trusts, whereby the various projects are placed in a trust that frees up capital to invest in new projects. The Securities and Exchange Board of India’s recent step of encouraging investments in infrastructure investment trusts is a move in the right direction, though expectations need to be moderated.
Unclogging the financial system
Many a time, developers do not have deep pockets or have difficulties raising the required capital from banks that are risk-averse or are concerned about their already large non-performing assets (NPAs) and acute asset-liability mismatches. This necessitates alternative solutions such as the development of capital markets.
The bond market is the best place to raise long-term finance, but it remains very underdeveloped in India. In addition to the development of corporate bond markets and local currency borrowing, there is also a need to explore further the use of municipal bonds, given the lack of finances by urban local bodies for city development. On the demand side, regulatory barriers that might impede institutional investment from pension, insurance, private equity and sovereign wealth funds must be carefully examined.
Overall, infrastructure development requires various stakeholders in the ecosystem to actively engage with each other. In particular, governments—with the assistance of MDBs—need to take the lead to crowd in long-term private capital by making infrastructure a more viable asset class.
Ramkishen S. Rajan and Sasidaran Gopalan are, respectively, vice-dean (research), Lee Kuan Yew School of Public Policy, National University of Singapore, and assistant professor, Graduate School of Public Policy, Nazarbayev University, Kazakhstan.
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