Forex boost to India's
infrastructure By Kunal Kumar Kundu
MUMBAI - India's ruling coalition of the United
Progressive Alliance (UPA) recently announced its desire
to use US$10 billion of the country's $119.3 billion in
foreign exchange reserves to accelerate investment in
the infrastructure sector.
Every government
tries to distinguish itself by implementing a few big
ideas that make a profound impact on people's lives. The
UPA government has just got a whiff of a mega project,
which, if executed well, could catapult India to
sustained 8% growth. Prime Minister Manmohan Singh is
keen on using part of the massive forex reserves to
drive big infrastructure projects in roads, ports,
high-speed railways and the power sector. What's more,
the UPA's most important but troublesome partner - the
left - is also game. In fact, the left has been strongly
pushing for this Keynesian exercise to boost employment
and growth.
With India's forex reserves
expanding by the day, this makes immense sense. When the
Reserve Bank of India (RBI) builds up forex reserves by
buying US bonds, poor India is actually lending the rich
US money at very low interest rates. This is perverse.
If India can increase its investment rate to, say 30% of
GDP, it would soak up all domestic savings as well as
remittances from abroad, foreign direct investment,
foreign portfolio investment and foreign aid. Assuming
an ICOR (incremental capital output ratio) of 3.7, this
is likely to translate into a growth rate of more than
8%.
The inflow of dollars from abroad plugs the
savings-investment gap as well as the current account
deficit. This model was followed by countries like
Japan, the Asian Tigers and other Southeast Asian
countries. The Asian Tigers in their heyday invested 40%
of GDP, so does China today. In contrast, investment in
India peaked at 26.9% in 1995-96, drifted down to 22.6%
in 1998-99 and then rose marginally to 23.3% in 2002-03.
The UPA government proposes to create special
purpose vehicles (SPVs) that can operate in a
public-private partnership framework. The SPVs will be
given rupee funds by the central bank - the RBI - at a
concession interest rate. It will virtually be like
deficit financing or printing currency as it used to be
done in the past. The SPVs will use their rupee
resources to buy up dollars from the RBI to fund their
imports. Thus the rupees released by the RBI will be
bought back by releasing dollars. The key to the entire
exercise is that it must be inflation-neutral and must
not lead to any excessive growth in the local money
supply resulting in general price rises.
The
other obvious advantage of adopting this instrument is
that it will avoid the crowding out of private
investment. Had the government borrowed from the market
to fund such massive investments, it would eat into bank
funds that would normally be accessed by the private
sector. This would generally result in the cost of funds
in the economy going up.
In any economic
comparison between the emerging Asian superpowers of
India and China, the most easily identifiable fault with
India is its comparatively poor quality of physical
infrastructure. In roads, rail, ports, power and water,
India lags miles behind China. The reason: It just does
not spend enough on them. According to a Morgan Stanley
research, China spent $260 billion - or 20% of its GDP -
on power, construction, transportation,
telecommunication and real estate in 2002. India spent
just $31 billion, or 6% of its GDP.
Also, the
cost of most infrastructure services in India runs about
50-100% higher than China. The electricity sector, for
example, is India's biggest infrastructure bottleneck,
with daily supply cuts in all but a few cities. The
result is an annual growth rate of around 6%, which,
while respectable enough in most circumstances, is at
least a couple of percentage points below its true
potential. According to Morgan Stanley, freight as a
percentage of total import value is about 11% in India,
compared with a 6% global average and 5% for developed
countries. There is also a higher lead time for trade:
six to 12 weeks for India's trade with the US, compared
with China's two to three weeks.
A World Bank
report issued almost three years ago said, "The shortage
of power is estimated at about 10% of the total
electrical energy and roughly 20% of peak capacity
requirement." Fifty years after independence, many rural
areas in India still have no electricity. Even measured
against neighboring countries, India's per capita
electricity consumption is very low - 270 kilowatt
hours/year as compared to 300 for Pakistan and 480 for
China.
Thus any stress on investment in
infrastructure is most welcome. However, that is not
problem-free either. It means expanding the fiscal
deficit by 2-3% of GDP. Can India spend its way out of
the muddle? Will this extra public investment generate
enough extra growth to ultimately pay for the additional
borrowing required? Experience does not say so. The link
between public investment and GDP growth is not
automatic. Higher levels of public investment in the
past did not generate growth any faster than today's.
High-quality public investment is unquestionably a spur,
but India has a long history of poor-quality public
investment.
Then the question is, where lies the
problem? Is India's infrastructure development caused by
the lack of financing or an inadequate business climate?
The rise in our forex reserves is actually a symptom of
our inability to create a climate for large-scale
investment. To fill that gap would require far more than
additional public investment.
Since practically
everything can be imported freely, the projects should
be able to import whatever technology or equipment they
need without any hassle. At the macro level, with
domestic savings falling short of domestic investments,
a deficit on the current account will result and the
reserves will drop. Starting with that objective puts
the cart before the horse. The risk in such an approach
is that the objective will be to somehow using up $10
billion, the imports will take place, and the projects
will remain incomplete. As it is, India has any number
of projects in the infrastructure sector lying
incomplete for want of resources. In successive budgets,
one finance minister after another has allocated
resources for the completion of such projects, with
little result.
Incomplete projects only add to
the fiscal burdens and do not create either jobs or help
growth. It is estimated that the government loses at
least Rs410 billion (US$9 billion) due to delays in more
than 300 projects, all above Rs200 million. One can only
imagine the total cost of delay if all central and state
government projects are put together. According to some
estimates, projects into which Rs1,000 billion has
already been sunk remain unfinished. A substantial part
of this investment will be lost forever and the
remaining will see time and cost overruns that will
mostly render them unviable.
Let's take the case
of Mumbai Trans Harbor Link. It is a 22 kilometer, $600
million bridge designed to deliver an expressway
connection between the commercial hub of Mumbai and its
new port at Navi (New) Mumbai. The project has been on
the drawing board for 20 years. In 2001, it was
announced that the project would be taken up on a
priority basis. But the global invitation for tender
pre-qualification has started only recently. The bridge
will take four years to build (assuming no unforeseen
time over-run, though cost over-run is a certainty) -
consigning traffic from the new port to a tedious
journey across crowded roads till it is done.
Ensuring transparency and proper project
management will help improve accountability and ensure
timely implementation of work and will have a crucial
multiplier effect on the whole economy. Since 1991,
India has had a policy of attracting private investment
into infrastructure. While some progress has been made,
it's nothing compared to what India needs. If the
private sector is to play a big role in meeting its
infrastructure demands, then India needs sectoral
policies and a regulatory framework conducive for
private investment.
Some examples will bring the
real problem to the fore.
Ever since the
liberalization policy was launched in 1991, the power
sector has been systematically starved of funds. Not
only has the private sector failed to contribute to
production capacity in any significant way, but
investment in transmission and maintenance of existing
plants has seen catastrophic declines. As a result, even
when new plants are commissioned, the problem of poor
transmission networks remains. Even the so-called reform
in the power sector (the Electricity Act, 2003) has many
loose ends that inhibit private sector initiative.
One area where the neglect of infrastructure
over the decades is most apparent is in the nation's
road network. Only 2% of Indian roads are four-lane, 34%
are two-lane, and 64% are single-lane. Nearly 50% of
Indian villages are yet to be connected by all-weather
roads. The progress of the much-vaunted Golden
Quadrilateral project in India (which was started to
link the four metros of Delhi, Mumbai, Chennai and
Kolkata with expressways) is a clear pointer to
institutional failure.
A similar weakness is all
too visible in the Indian port system. Decrepit and
bogged down by lack of modernization, Indian ports are a
nightmare to importers. The old state-run Mumbai port is
a classic example: it suffers from inefficiency, poor
draught, low productivity, high costs and long vessel
turnaround times. Mumbai's inadequacies have benefited
Colombo in Sri Lanka, which enjoys growing container
volumes.
Efforts to develop India's ports have
all too often been stymied by the creaking bureaucracy.
Bureaucratic problems encountered in the private
tendering processes at Mundra in northwestern India and
in the conversion of two break bulk berths to a new
container terminal at Nava Sheva under the Jawaharlal
Nehru Port Trust have slowed down the development of
ports in India.
Overall, as industrial
development came to be divorced from efficiency and
productivity over the years, India's ability to compete
globally was seriously compromised. In contrast, during
the same period, Chinese manufacturers became
increasingly competitive. And, infrastructure made all
the difference. The issue is, unlike China, where new
highways, bridges and ports can be fast-tracked on
central government orders, India must go through a
time-consuming consensus-building process among various
political constituents. Then there are bureaucratic
delays, corruption and politician-criminal nexus - all
of which act as a hindrance.
A recent World Bank
report states that in India it takes 89 days to start a
business (with 11 separate procedures), 425 days to
enforce contracts (40 procedures), 67 days to register
property (six procedures) and 10 years to resolve
insolvency. In comparison, the respective figures are 41
days, 241 days, 32 days and 2.4 years for China. This
calculation of course does not take into account the
time required to collect information about registration
procedures. The number of procedures does involve
transaction costs, but ultimately, it is the time taken
that matters. Among a set of nine developing country
counterparts, India pretty much figures at the bottom of
the heap as far as various investment climate indicators
are considered.
An investor aiming to invest in
India faces a variety of uncertainties in carrying out a
project appraisal. The costs of inputs such as labor,
capital and land should be relatively easy to calculate,
but the total cost of doing business also includes
transaction costs, many of which are hidden and
intangible. They depend on institutions too. Good
institutions, from an investor's perspective, should
minimize the hidden, human-made costs of doing business.
High transaction costs deter domestic as well as foreign
private investment.
Unfortunately, in India,
institutions have, more often than not, acted as a
hindrance rather than a catalyst. Thus mere announcement
of using forex reserves for infrastructure development
without making a strong statement of carrying out the
required institutional reform will hardly work.
Kunal Kumar Kundu is a
senior economist with a leading bilateral Chamber of
Commerce in India. He has a Masters in Economics with
specialization in econometrics from the University of
Calcutta.
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