Inside India’s infra riddle

Ironically, India spared no expense in promoting the Commonwealth Games, seeing them as a chance to highlight its remarkable economic success of recent years, and reap some of the glory that China enjoyed at the last Summer Olympics.

At the end of the day, the teams turned up, despite a feared boycott, and all is (sort of) well. Still, the question remains: how could such a showcase project lead to such public upset, especially with all the world watching? And, more to the point, what does it say about the likelihood of India achieving its much-touted infrastructure transformation?

Crisis-driven policy

Sandeep Sudan, Regional Head for North India with Mahindra Special Services Group, contends that one root issue is simply the Indian character.

“Indians have a very reactive mentality. So, when the tsunami happened, everybody started talking about putting warning systems in place, so that we would be prepared. Or, when an earthquake hit Latur, everybody started going back to their architects to check their buildings’ strength.”
In other words, change tends to be crisis-driven in India. In this case, the Commonwealth Games debacle could ultimately prove to be beneficial.

But, as the government well knows, the country’s daunting deficits in power production and distribution, roads, ports, airports, telecommunications, irrigation, and urban infrastructure – the list goes on – are already a great handicap on growth, and could ultimately choke it off even further.

Social context and contrasts

India looks at first to have many of the attributes needed to address this situation. It boasts reasonably developed financial markets, innovative and sophisticated businesses (an increasing number of which now have a real global reach), an open social system, and vast markets.

But there are formidable hurdles as well, many again rooted in the nature of Indian society. Infrastructure development anywhere cannot be viewed in isolation. But in India, as perhaps nowhere else, it has to be dealt with as just one element – however important – in a much wider social context.

This stands in stark contrast with China’s infrastructure rollout of recent years, where a very different political and social structure enabled the wholesale construction of coordinated mega-projects by government fiat.

In India’s case, as the world’s largest democracy – as Prime Minister Manmohan Singh noted at the World Economic Forum’s India Economic Summit a year ago – the government’s focus is not only on fast but also on inclusive growth.

At least the growth is there: GDP grew at about 9% for the five years preceding the GFC. This was projected (a year ago) to dip to 6.5% for 2009-10. In reality, however, approximately 8.5% was achieved. And a return to 9-10% numbers seems likely, according to Rajeev Malik, Senior Economist with CLSA Asia Pacific Markets.

The underlying growth story

Despite these growth prospects, though, there are always many question marks in India. And in economic matters, government decisions and the pace of reform are constant concerns. However, CLSA’s Malik remains optimistic.

“Two questions that often come up about India are: can we continue to grow by 9-10% in a sustained manner, and will we grow faster than China? I think both are the wrong questions. The real question is how has this country, with its pathetic and obsolete infrastructure, actually ended up growing at 8-9%; and what potential growth rates are possible if only a small percentage, say 30%, of the infrastructure-related problems are solved?”

Rahul Bhasin, managing partner with Baring Private Equity Partners India, shares Malik’s confidence. “The GDP growth is for real,” he told AVCJ. “And the structural drivers are not going to change because of politics, or who has a view on what. The percentage of the population entering their working years is increasing every year, and will continue to do so for at least the next 30-odd years. So broadly, you see higher value-added jobs in India, which means there are more opportunities along those lines.”

Unfortunately, however, that’s only true for a minority of the population. For the rest, widespread weakness in the education system – and the exclusion of a large swathe of the lower orders and women in particular – creates very real problems, even in the rollout of today’s infrastructure projects.

Delivering to local communities

CEO of Essar Projects Business Group Alwyn Keith Bowden has hands-on experience in infrastructure project development in India, and his ground-level view is rather more hard-edged than most official government and corporate statements.

“Local communities throughout India have not really seen the benefit of those assets that have been brought to them. And that has resulted in great difficulties in getting through these projects, because of interference coming from these communities, including destructive acts and delays that have a real impact on work processes… They demand that you undertake certain additional work for them.”

He cites his experience with power plants, as an example, where a foreign builder suddenly realizes that the local community actually receives almost zero benefit from the power plant in question, yet has to put up with power cuts more than half of every day.

“The level of real employment that is delivered to communities like that from the projects themselves is limited. Or, when roads are being built through local communities, there is no way for the villagers to get across those roads.”

Other key issues include a bureaucracy geared toward making sure that certain parties get through the documentation process while others don’t. This often creates insurmountable problems for international companies, not to mention bad word-of-mouth on alleged Indian infrastructure opportunities.

Yet another issue is the widespread lack of quality control on individual projects. “This is a country where there is a predilection for lowest cost, and the whole of the market gravitates toward this,” says Bowden. “This leads to some serious lapses, as can be easily seen on roads in Mumbai, for instance.” The low-quality work amounts to a trap for overseas investors in particular, in terms of being responsible for additional maintenance charges due to quality not being insisted on through the initial delivery process.

Nevertheless on balance the situation is improving. “There are a lot of issues to be faced. But I think the country is increasingly facing them, as are companies like ours. The infrastructure is starting to go in, it’s turning around. And the opportunity is huge. But it’s something you have to go into with your eyes open.”

Productivity and the private sector

Government policy is the main factor that has to be borne in mind in the infrastructure story. The government, with its command economy heritage, would prefer this happens primarily via public-private partnerships (PPPs). But the creation of compelling investment models, from the private sector’s standpoint, is far from a fait d’accompli. Much remains to be done to mitigate the inertia, if not outright roadblock, that India’s bureaucracy represents for foreign investors, whose investment interest and expertise will also be vital.

Bhasin confirms the historic role of the command economy in India’s post-war development. “In 1990, roughly 30% of Indian GDP was in the hands of the private sector. Today, that’s about 60%. The productivity of capital in the private sector is significantly higher, and this percentage is rising every year because growth in the private sector is much faster than in the public sector. So as the proportion changes, so will the structural growth,” he told AVCJ. In theory at least.

CLSA’s Malik adds, “What happens with productivity is ultimately going to be a function of how quickly, and to what extent, some of the infrastructure deficits are corrected.” He too sees progress, though, especially with improvement in FDI inflows into the country, and India’s prevailing current account deficit.

Deficit and deregulation

“There are two important aspects of change that the current account deficit forces on to the government,” Malik continues. “One is to progressively liberalize. India is now back to growing at 8-9%, with a loan-to-GDP ratio in the low 50s, the second lowest in the region. Capital loan growth will be much faster than nominal GDP growth over the next few years, which has to contribute to growth. But secondly, the current account deficit will force the government to open up many other sectors. And in fact, I will not be surprised if over the next few months [the government] eases the cap on foreign investment in local currency debt.”

The crucial issue going forward is that the now-dominant service sector won’t be able to absorb all the new labor market entrants. Therefore, beefing up the country’s manufacturing segment will be key. But in India, unlike most countries in Asia, manufacturing is afflicted by two major negatives: it is overtaxed and, as yet, the crucial enabling physical infrastructure is not in place.

Malik concedes that the government is trying to address these problems, but he still sees ongoing weakness regarding the inadequacy of education provision.

“The biggest issue for corporate India is that, with the large labor intake, they’ll have to develop in-house education programs to train these people, because most of the public institutions can’t or don’t … The situation is beginning to echo what people used to say about India: because it has power shortages, it can’t grow. But it did grow. How? The same way. Many of the businesses that have driven growth in the country simply set up their own power supplies. Certainly, it was at significant extra cost. But when the need is clear…”

Malik’s inference is that the same will happen in workforce training as in infrastructure development, since both are critical areas. And as he avers, in India the shortest distance between two points is never a straight line. 

Further reading

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Ascent invests India infrastructure, real estate with IVRCL Assets

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• 05 Oct 2010

Funding Asian infrastructure: The ancillary factors

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• 25 Aug 2010

Fund structure for infrastructure

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• 08 Jun 2010

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• Topics
• South Asia
• Infrastructure
• Infrastructure
• Baring Private Equity Partners India
• Rahul Bhasin