PUBLIC INFRASTRUCTURE INVESTMENT – THE ONLY WAY FOR GROWTH
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After a landslide electoral victory, the Narendra Modi-led government has kick-started a revolution with the government relaxing controls, decentralizing the powers, announcing the smart cities’ project and industrial corridors, and many other reforms. The Modi government came into power with a whopping majority on the promise of reviving India’s economy. However, the prime minister and his government have been criticised for the slow pace of the reform push and poor implementation at the ground level. The governor of the Reserve Bank of India (RBI) too has expressed his views about the expectations from the Modi government.
According to him, this government came in with tremendous expectations and these were probably unrealistic. Such high expectations from the government were probably because of Narendra Modi’s 12-year track record of successfully running the business-friendly state of Gujarat. However, the job of running India has been a far tougher task for Modi over the last one year. At the time his government took over, the immediate situation was precarious and the Indian economy was struggling with higher inflation, stagnant economic growth, declining industrial activity, out-of-shape public finances, and many such serious issues.
However, the government has made some sensible moves to improve the domestic economy and the investment environment across India. The major hurdle for the economy - the interest rate - has been turning positive for the economy. The recent trends in inflation measured by both Wholesale Price Index (WPI) and Consumer Price Index (CPI) are coming down fast, which will give the central bank leeway to further cut further the interest rate. Though the gloom concerned with Indian economy seems to have disappeared after the recent data flows on macro economic indicators, there has been very less materialisation in terms of ground realities.
Hence the government is now emphasizing on public investments since private investments are taking their own good time. Previously, the majority government had tightened its public spending to curtail or manage public finances. Hence it will be very interesting to see which of the infrastructure sub-sectors will benefit out of this new move. The problem though is that despite its majority in the parliament, the government has its own shortcomings to overcome. This issue’s cover story therefore dwells upon the government’s infrastructural spending as a tool to revive the economy and its capabilities to do so.[PAGE BREAK]
Infrastructure’s Multiplier Effect
Infrastructure spending on power, roads & highways, electricity distribution, oil & gas distribution, air and rail transportation, shipping & ports, drinking & sewage water systems, telecommunication, etc. is the foundation of any modern economy. According to empirical studies it is clear that modern and well-functioning infrastructure is vital to a country’s competitiveness. Further, as per many economic observers, the USA’s ability to maintain a competitive edge throughout most of the 20th century was in large part due to its excellent infrastructure.
Infrastructure development results in economic growth in three ways: (a) spending on materials spurs development of suppliers, (b) spending on labour provides jobs and those employed will spend more, thereby resulting in GDP growth, and (c) good infrastructure creates compounded value in terms of production capacities and efficiencies. Interestingly, infrastructural spending has a huge multiplier effect. This is so especially if the government infrastructural spending results in higher multiplier effect. In other words, developing countries really benefit from government investment which can build the productive capacity of the economy, resulting in beneficial long-term effects.
For example, if the government sets up a power plant, it not only generates employment directly through construction and operations of the power plant but can also create an industrial base around the plant. These industries would get more entrepreneurs and employ more labour. This employment would further increase public spending on goods and services, creating a virtuous cycle. Similarly, when government constructs a road through a backward area, it brings the area close to education, healthcare, employment and markets. Infrastructure is the key to wiping out poverty.
To see the multiplier effect, one can always consider the classic example of China. The Chinese economy’s rapid recovery during the recent financial crisis was predominantly because of its aggressive Yuan 4 trillion investment. Hence government spending has played a considerable role in determining China’s economical performance. During the same period, the Chinese public capital formation had been growing at the fastest speed in the world. Tremendous investments and improvements were made in irrigation, sewage systems, roads & highway networks, rail & air transportation, shipping infrastructure, schools, hospitals, electrical transmission, oil & gas distribution network, etc. As a result, China was the only developing country to get listed on the World Bank Logistics Performance Index, comparable to industrially advanced countries.
The quantum of this multiplier effect is significantly large and is the only reason why the Chinese government’s spending on infrastructure development was effective in preventing an economic slowdown and recession even though it was reckless and highly inefficient in some instances. Inflation in China is strongly and positively correlated with GDP growth, contrary to what we see in developed countries like the USA. However, the International Monetary Fund (IMF) claimed that increasing spending on public infrastructure would raise output in the short term by bolstering aggregate demand and in the long term by raising aggregate supply.
Some of the practical studies have observed that the estimated government spending multiplier effect for developed countries such as the USA is commonly near to 1 and is in the range of 0.6 to 1.2. The primary reason for expecting a small multiplier effect is that capacity utilisation in developed countries is sufficiently high and markets are adequately efficient. However, during severe recessions, especially in a situation with a zero interest rate, the multiplier effect in developed countries could be potentially higher than 1.
According to the IMF, for most of the developed economies, every incremental dollar invested in infrastructure has the potential to add 40 cents to GDP in the first year and USD 1.50 in the next four years after the initial spending. The global rating agency Standard & Poor’s (S&P) clearly sees economic benefits for G20 countries through increasing public infrastructure spending. In January 2015 the rating agency estimated that an increase in spending amounting to 1 per cent of real GDP could result in a multiplier effect as high as 2.5 for the next three-year period.
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India’s Infrastructural Shortfall
India’s infrastructure development has been traditionally low compared to competing countries such as China. There has been an indisputable need with significant potential in the Indian infrastructural segment. The recent high-profile infrastructural development lacks the power to satisfy the needs of the Indian economy which is growing at a heady 7 per cent annually and the sector is struggling with inefficiency, corruption, and uncontrollable urbanisation. One of the biggest challenges for India is to create expansive new urban areas with adequate infrastructural facilities.
Millions of people are shifting from the countryside to unorganised establishments in cities every year. By 2030, about 40 per cent of the country’s population will be living in cities, according to certain estimates. Heavy urbanisation across various parts of India creates a huge demand for urban infrastructural need which has tremendous shortfall in India. To illustrate, New Delhi alone is adding 1,400 new cars a day on its roads, which is unable to handle current volumes. The industrial establishments across the country experience almost daily power outages.
Onus on the Government
No doubt the government is taking steps to improvise the country’s infrastructural situation and implementing a five-year USD 1 trillion infrastructural investment plan targeted to overcome the deficiencies. The government has given extra thrust to implement and expand the public private partnership (PPP) model considering condition of its public finances. Since 2007, private companies have pumped considerable amount of money into Indian infrastructure projects, but with disappointing results sometimes. Some of these investments by private companies included Chennai’s new airport terminal, Delhi’s smart airport, an express-rail link in Delhi, and one of the biggest power plant constructions in northwest India.
However, the new government has tried to change the scenario and is promoting private investments. One of the major steps towards achieving its aim of improving India’s ranking on the Ease of Doing Business Index was to launch an eBiz portal (www.ebiz.gov.in). To attract foreign investments in India and improve India’s relations with the other countries, the prime minister has extensively travelled 17 times out of the country and invited global businesses to look at India as an attractive investment destination.
However, there has been no Big Bang investments coming to India in the first year and the issue of ease of doing business still needs to be addressed in a major way. It must be taken into account though that there is always a time lag between the action being taken and investments coming in. How long will it take is difficult to tell, but based on the opinion of various experts, India should definitely start seeing results in the days ahead. The corporates are skeptical about committing big money based only on this ‘positive intent’. In the last 4-5 years hardly any investments have taken place. Further, the corporates are shying from capital expenditure as there is no visibility of sharp improvement in demand.
As per the credit rating agency CRISIL’s survey of 192 listed key sector companies, there was a 4 per cent decline in capex plans for 2015-16 and an 11 per cent yearly decline in the capex plans of private sector companies due to subdued spending in 2014-15. With no capital investment, no job creation, and no increase in people’s spending power, obviously it is very difficult to sustain the current pace of the economy. Hence the message is very loud and clear: kickstart the investment cycle through public investment.[PAGE BREAK]
The Crucial Sectors
Here are some of the sectors that investors should keep tabs on:
Roads & Highways:
The award activity of NHAI has almost been stagnant for the last 30 months till H1 FY15. Interestingly, the NHAI has awarded almost all projects on a PPP model since FY07. Many of these projects did not reach the implementation phase; rather some of them have been cancelled. As the asset portfolio of leading private developers grew, the debt burden too grew. Due to economic slowdown and lower returns in road bid projects, the activity has stalled due to lack of appetite and capacity. However, the government has now changed the process and it has decided to fund the bulk national highway projects through public finances, at least till the private sector’s balance-sheets get back to shape.
The NHAI has a pipeline of 14,600 kilometres of highway projects that need to be awarded as part of the National Highway Development Plan (NHDP), a seven-phase national highway development plan conceived over the years 1999-2004. Furthermore, the government recently approved a comprehensive exit policy for the roads sector, allowing them to quit a project two years after completion. Further, to speed up infrastructural development, the government has decided to gain required requisites such as land and environmental clearance and then go for bidding the project. So these positive developments will definitely give impetus to the road & highway development sector.
Railways:
The government has clearly expressed its intention to improvise and expand the railway network since it can play an important role in India’s GDP growth. The flagship project of railways, the Dedicated Freight Corridor (DFC), is poised to resume its ordering process after a hiatus of 18 months. DFC comprises two corridors aggregating 3,300 kilometres. The civil work is expected to start very soon as 96 per cent of the land has been acquired for these stretches and all the environmental clearances and other approvals are in place, except for coastal clearance. In addition to the civil contracts, we expect electrical, signalling and telecom contracts to be awarded for the entire stretch.
With increasing urbanisation in India, the emergence of the first large metro network in India kicked off in FY99 in Delhi. After Delhi, now the metro is operation has been extended to other six cities. Further, there are another set of 12 cities lined up with advanced stages of planning. Hence, metro development will present a big opportunity in the days ahead.[PAGE BREAK]
Urban Development:
Uncontrollable urbanisation is one of the biggest challenges for India. To curtail the unorganised residential establishments, the government is taking proactive steps with plans to develop seven industrial corridors and 100 smart cities to create planned urban clusters with modern infrastructure. Though most of the projects are in early stages of conceptualisation, actual activity at the ground level will take some time. A project that has however recorded good progress is the Delhi-Mumbai Industrial Corridor (DMIC). The DMIC is being developed in concurrence with the DFC to create a model industrial corridor in India with state-of-the-art infrastructure to enable the development of a global manufacturing hub.
The Way Ahead
While many are criticizing the new government for not doing great work within the past one year, the government has actually taken the right steps to create a conducive environment for attracting investments. Rather than taking big initiatives, the government has focused initially on repairing the economy. The government is sensitive to investors’ concerns and is looking into addressing economic issues. Hence though the changes in the first year may not qualify as Big Bang reforms, the government has taken measures that could lay the foundation for long-term growth. Of these, credit must certainly go to the government for injecting optimism in the economy.
Some of the key reforms taken by the government over the last one year include the hike in foreign direct investment (FDI) cap in insurance from 26 per cent to 49 per cent, opening up defence production to foreign investors, and the announcement of 100 smart cities. The government has also been trying to make life simple for investors and make it easy for setting up business ventures so as to push manufacturing. If there is one thing that will put the icing on the cake, it is the ambitious indirect tax reform in the form of the Goods & Service Tax, which is pending for approval with the Rajya Sabha.
In order to increase and facilitate investment in a simpler and faster way, the government’s amendments to the Land Acquisition Act 2013 was caught on the back foot with protests from farmers’ unions, opposition lawmakers, and civil society groups. The opposition was vociferous in its criticism of the Act, stating that the amendments are anti-farmers and will favour private corporations. According to public policy experts, land acquisition is the single-biggest hurdle to infrastructure development in India. A 2013 report by the ratings agency ICRA said eight out of 20 major projects, including roads, coal mines, and steel mills worth more than Rs 1 trillion were shelved in 2011 and 2012 because of the failure to acquire land.
Meanwhile, in order to push transportation infrastructure, there has been an increase in outlays in the FY16 budget for highways and the railways sector and the projects will be funded by enhanced borrowings from public institutions. Hence, the National Highways Authority of India (NHAI) and Indian Railway Finance Corporation (IRFC) would have to create new financial models to support the enhanced borrowing levels. Given this scenario, while the direction seems to be crystal clear, the question is about when all the changes will begin to actually take place.