## Thursday, April 13, 2017

### Retreat from private infrastructure projects

by Ajay Shah.

#### The case for private participation in infrastructure

Many years ago, most infrastructure in India was government owned. Policy thinkers strenuously argued for greater private participation, for the following reasons:

• Private ownership would give better hardware, as a private person cares about what is being built. It would also give better safekeeping of the assets, as a private person cares about his things.
• Private owners would strenuously push for adequate user charges, and act as a counterweight against the biases of the Indian political system in favour of low user charges and thus a burden upon the exchequer.
• If a project is unviable, the private sector will more clearly say so and walk away, in contrast with the government processes which will build infrastructure in respond to political pressures.
• Indian public finance would be better off when its balance sheet is freed from infrastructure assets, and these are instead held by listed utilities who issue debt and equity. It would become possible to bring the vast global capital to bear on these markets and deliver low cost financing.

For some years, private participation in infrastructure grew well, but things have changed sharply. Here are three key pictures. At each point in the time-series, we sum up the value of infrastructure projects in the CMIE Capex database that are classified as being under implementation' by CMIE. The time series of the stock of under implementation' projects changes from $t$ to $t+1$ because some old projects are commissioned, some are abandoned, and some new projects appear into the list.

 Private infrastructure projects that are Under implementation in the CMIE Capex database

As the graph above shows, we got a huge increase from 2003 to 2011: a gain of roughly 10x in nominal rupees. By 2011, there was a stock of roughly Rs.25 trillion rupees of private infrastructure investment projects that were under implementation.

After  that, private infrastructure projects have receded substantially. We have a decline of Rs.5 trillion in nominal terms. If inflation were taken into account, that is a decline of another 25%.

How has government infrastructure investment activity fared?

 Government infrastructure projects that are Under  implementation in the CMIE Capex database

This shows a picture of steady growth. In 2011, both private and government projects were at roughly Rs.25 trillion. From there, the private projects have dropped to Rs.20 trillion while the government has gone on to Rs.38 trillion. There is growth in the stock of government infrastructure investment projects under implementation, even after you take out the 25% increase in prices from 2011 till today.

It is quite a reversal for the long-held objective of having greater private participation in infrastructure.

What's the overall picture of infrastructure investment?

 Total infrastructure projects that are Under implementation in the CMIE Capex database

Putting the two together, there is broad stability from 2013 onwards (but a decline in real terms once you take out inflation). What has not been widely observed is the compositional change within this overall number: the private sector is losing ground and government infrastructure projects are gaining ground.

#### Implications

In my view, the original logic in favour of greater private participation in infrastructure remains. The private sector will use capital more effectively, deliver a better incremental capital-output ratio, and take care of assets better. Conversely, public sector domination of infrastructure investment is going to deliver reduced bang for the buck. The compositional shift in favour of public infrastructure projects is a weakness.

#### Where did we go wrong?

In the first wave of pushing private sector participation, we did not adequately understand that private participation in infrastructure requires complex institutional machinery. The government's role in infrastructure is in three parts: Planning, Contracting and Regulating. Clear structures needed to be established for each of these three pillars. Mechanisms were required for resolving disputes and protecting cashflows from user charges. We needed to keep our eye on the prize: the projects that come out of all the complexities of the early stage and make it into the listed space, as boring utilities who just collect user charges and do O&M. With the benefit of hindsight, we went  about private sector investment in infrastructure in a slipshod manner.

In the recent period, instead of fixing these institutional complexities, there has been an excessive willingness to give up on private sector participation and make do with muscular State-led investment. It feels like an entire generation of institutional memory, about the problems of public sector infrastructure investment, has been lost. We are now running a Chinese-style risk of large investments going in with low returns in terms of incremental GDP per unit investment.

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<<<<<< In the first wave of pushing private sector participation, we did not adequately understand that private participation in infrastructure requires complex institutional machinery. The government's role in infrastructure is in three parts: Planning, Contracting and Regulating. Clear structures needed to be established for each of these three pillars. Mechanisms were required for resolving disputes and protecting cashflows from user charges. >>>>>>>

Regarding the complex institutional machinery - I wonder why institutions in India are exempt from the time-tested notion that institutions develop/evolve ALONG WITH the rest of the economy ??

A classic supply side problem. Where will the manpower come from (to fill the vacancies within these complex institutions) ?

2. I think it is more private sector incapacity, following stuck projects and accumulation of non-performing assets, than a shift in policy preference to the public sector. There are few infrastructure companies that can actually develop large projects that are not under severe financial strain

3. Sir,

Case in point is the current power sector scenario in India.

Demand-Supply Scenario:
- Central Electricity Authority (CEA) in its draft National Electricity Plan (NEP) (published in Dec'17 for stakeholder comments) suggests that thermal PLF would go down to less than 50% in next 5 years. (http://www.cea.nic.in/reports/committee/nep/nep_dec.pdf)
- Average whole sale power prices in Indian Energy Exchange (IEX) for Western Region Power Plants (http://www.iexindia.com/marketdata/areaprice.aspx) for year 2016 was Rs. 2.00/unit (after accounting for Rs. 0.25/unit on account of transmission losses & charges) - just barely meets the coal cost.

Private Sector Response:
- Private IPPs have already responded to these price signals and all private thermal capacities which are in planning stage have been shelved.
- Even most of the under construction private thermal plants have been shelved as it makes no sense to invest further to complete the project and sell at coal cost.

Public Sector Response:
- However, Investments by Central & State Utilities in thermal capacity addition continue to remain at steady pace irrespective of the fact that 50% of existing thermal capacity is going to be idle in coming days and it might make more sense to buy from these capacities rather than setting up own plants. A just a couple of recent stories
- Even bigger issue with these capacity addition programs of State & Central Utilities is that these thermal plants are set-up at economically unviable locations and are inherently uncompetitive. For example, for the thermal plant set-up in Tamil Nadu, coal has to be transported from coal rich Chhattisgarh over a distance of about 2000 kms and the transportation cost itself could itself make up for almost 30%-50% of generation cost.
- Even after these plants are set-up at huge cost of say Rs. 10,000 cr, actually these plants are rarely utilized because the 'variable cost' of generation itself is about Rs. 3.00-4.00/unit and it makes more sense to shut these plants and buy from open market at Rs. 2.00-3.00/unit from private players there by saving Rs. 2.00/unit on every unit of generation. The below story is just one of these many instances which is happening across almost all states:
http://www.hindustantimes.com/punjab/pspcl-underused-own-plants-put-rs-1-428-crore-burden-on-consumers/story-gPqHNJQTvnGeXklakrR2KJ.html

Current Govt Policies
- Current govt policy though mandates competitive bidding for procurement from private players for State Discoms, it allows for purchase of power from State Genco at cost plus route. So, when his returns are guaranteed, State Gencos do not really bother about economic viability of the plants before they are set-up
- Further, Current govt policy allows the entire power procurement of State Discoms as a 'pass-thru' in the retail tariffs. Neither a retail customer has a choice of supplier to say 'no' to these higher retail tariffs. So, State Discoms also are least bothered about high cost of power procurement from their own State Gencos.

Hope
- The need of hour is to initiate distribution side reforms in the power sector. A competitive distribution sector will cut the flab across the entire value chain and ensure wasteful investments are minimised.
- The draft amendments to electricity act which had proposed introduction of multiple suppliers annd competition in distribution is in cold storage for quite sometime. Lets hope it gets passed soon.
http://pib.nic.in/newsite/PrintRelease.aspx?relid=113779
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