Roads, rent and slow growth

By now it is normal to see the Indian government constitute an enquiry or set up a commission whenever a scandal surfaces or a calamity befalls the country. The reports published by these bodies are greeted with as much excitement as the weather report. The publication of the Comptroller and Auditor General (CAG) of India’s report on 2G spectrum allocation in November 2010 changed all of that. Three years on, with the economy weakened, with corporate India humbled, with civil servants terrified of signing off on almost anything, one can safely say that CAG’s 2G report marks a watershed in India’s development. But how did all this happen? How did India get here and where will it go from here as an infrastructure-starved democracy?

Starting in the late 1990s, India’s need to attract private capital into public infrastructure projects led to the government giving generous concessions to private sector infrastructure builders. So, for example, at the turn of the century, the first half a dozen or so of public-private-partnership (PPP) road projects were tendered successfully by the National Highways Authority of India on the pre-condition that the government pays an annuity to the builders of these roads.

The rot began once the Indian economy shifted into high gear from 2004 onwards. By 2005, the first few PPP road projects were highly profitably thanks to a combination of conservative assumptions on key parameters such as traffic growth, interest costs and construction costs.

Combined with growing global investor interest in India the realization that there was money to be made in providing public infrastructure set off a gold rush. Banks and foreign investors participated in a stampede to finance these projects. The governing class stood on a high alert to collect rents and the promoter community willingly acted as the go-between the eager financiers of infrastructure and public servants who are the gatekeepers to PPP contracts.

Soon a new model was established for winning PPP projects. In this model, a government agency would invite bids for a public works project or for an infrastructure contract or for the utilization of a natural resource. The tender issuing government agency would then collude with its accomplices in the promoter community and provide them visibility on post-contractual concessions. As a result, the “connected” bidders would bid at uneconomically low rates which other bidders could not hope to match. Once the contract had been awarded to the friendly operator, the operator maximized his profit by either asking the government for more funds or higher tariffs or by imposing levies on the public. Such post-contractual opportunism became the defining theme of Indian infrastructure in the second half of the 1990s.

As the excesses got out of hand, a few civil servants in New Delhi wrinkled their noses and wondered what could be done to arrest the rot. And then in November 2010 came the CAG’s report on the 2G spectrum allocation.

Enough has been written on this now legendary report and the point does not require elaboration. The 2G report along with the reports published between 2010-12 by CAG on the Commonwealth Games, the Delhi airport and the allocation of coal blocks laid bare the rent-seeking behaviour highlighted above.

Soon, civil servants stopped signing off files on issues ranging from environmental clearances to access to coal blocks and ministers sought the shelter of committees. Gradually, the infrastructure and mining sectors slowed. Production of natural resources either stagnated (coal) or fell sharply (iron ore, gas) and this hit downstream sectors (steel, power).

Catalysed by CAG and armed with the powers of the Right to Information Act, a legion of non-governmental organizations (some sponsored by self-interested private sector firms), activists and the press, now relentlessly probe infrastructure projects for signs of wrongdoing. As a result, the governing class now has no option but to move to a more transparent way of functioning.

In particular, it is becoming increasingly clear that India will create a new set of norms under which PPP projects will be bid out by the government. But the bulk of the execution risk stays with the state (so if, for example, the cost of fuel goes up, then this will be reflected in the final price of power sold to the state electricity board). In addition, the promised rate of return from these projects will be marginally above the cost of capital (as opposed to the 25% plus returns promised by power companies that went public in 2009).

However, given the chasm between the old way of doing business and the new norms which are evolving, what are emerging are a set of “stopgaps” to prevent the economy from seizing up further. These stopgap arrangements are either in the form of committees recommending price increases (to bail out stricken projects) or in the form of pro-industry regulators.

The bailouts are typically in the form of recommendations being made by a committee constituting of high-integrity individuals who are seeking to relieve the stress on the economy by allowing operators to increase prices.

The latter (i.e., pro-industry regulators) is usually in the form of more rational regulators with the Telecom Regulatory Authority of India (Trai) being a case in point. The new Trai chairman’s recent statements in support of 3G roaming agreements, a more permissive mergers and acquisitions regime and lower reserve prices for spectrum auctions is the first definitive change in attitude towards the industry after a long time.

Saurabh Mukherjea and Ritika Mankar Mukherjee are, respectively, CEO of institutional equities and economist, at Ambit Capital.