Governance in India: Infrastructure

Introduction

India’s emerging economic power, like that of neighboring China, has been spurred by its momentous growth rates in the past few decades. But years of underinvestment in infrastructure have left the country with poorly functioning transit systems and power grids that have further endangered its slowing economy. Growth slipped from 10.5 percent in 2010 to 4.8 percent in 2013, according to the World Bank. Burgeoning trade is putting pressure on India’s inefficient ports, and rapid urbanization is straining the country’s unreliable electricity and water networks. Bureaucratic red tape and political inertia have thwarted the success of foreign partnerships, discouraging further investment. Such large-scale failures have raised sharp debate about how the country’s infrastructure weaknesses could threaten its economic future.

A Broken Grid

India’s infrastructure sector has battled decades of dysfunction. Post-independence, the government led a state-centric approach to infrastructure development by building, owning, and managing projects. The system created a host of inefficiencies; after years of unmet demand and growing financial constraints, the government opened the sector to private investment as part of its economic liberalization in the early 1990s. Yet the success of the reforms has been mixed; private participation has fallen short of expectations, and energy shortfalls have proliferated. India ranked 85^th out of 148 countries for its infrastructure in the World Economic Forum’s most recent Global Competitiveness Report. Delhi and Mumbai, its two largest cities, ranked far below other regional capitals like Beijing and Bangkok for infrastructure in a UN report. The endemic dysfunction has bruised India’s international standing and discouraged direly needed outside investment.

Power: The chronic electricity shortage is viewed by the government and international business community as one of the gravest threats to India’s growth. While GDP burgeoned at around 8 percent until 2010, electricity generation only increased at 4.9 percent a year, according to the World Bank. Thermal power—which includes gas, liquid fuel, and coal—accounts for roughly two-thirds of power generation, with most of it coming from coal. Other sources include hydro, wind, solar, and nuclear.

The electricity sector is dominated by large, government-owned utilities at both national and state levels, and in earlier decades of development, jurisdictional conflicts in the sector sometimes led to inefficiencies in the use of capital, says Sunila Kale, associate professor at the University of Washington. Institutional boundaries of the energy grid corresponded neatly to those of political constituencies, Kale writes, meaning a close relationship between the government and State Electricity Boards—which generated and distributed power—tied utility power to electoral power. “In the 1960s and 70s, for example, when technologies of power generation were favoring greater economies of scale, state governments were limiting the size of generating units because they were trying to serve their own territories, leading to an inefficient use of capital.”

Today, the national transmission grid is in dire need of investment, and distribution companies, largely state-owned, are financially insolvent. Electricity theft has become common practice, while roughly one-third of the country goes without access. Two massive electric-grid failures in mid-2012 deprived almost 650 million people of electricity for days in northern India, raising serious concerns about the government’s ability to meet the country’s power needs. Dwindling energy resources exacerbate the problem; despite attempts at power sector reform, including the landmark 2003 Electricity Act, experts say gaps remain between suggested measures—such as privatization of the distribution sector, tariff reform, and anti-theft measures—and their implementation.

Progress in the nuclear sector has lent some hope. In 2008, India signed a historic civil nuclear deal with the United States that, among other things, promised U.S. assistance to India’s civilian nuclear energy program. Delhi also signed similar pacts with Russia and France. The World Nuclear Association says that the country has a "flourishing” and largely indigenous nuclear power program, aiming to supply a quarter of its electricity from nuclear power by 2050. However, India has so far signed only one deal with an American company due to a liability law in the agreement. In September 2014, a new administration in Delhi, led by Prime Minister Narendra Modi, inked a civil nuclear deal with Australia that allowed Sydney to sell uranium to India, as well as increase supplies of conventional fuel to help overcome the country’s chronic shortages.

Transport: India’s roads haul roughly two-thirds of its freight and 85 percent of passenger traffic. Only half of the country is paved, and less than a quarter of its national highways meet required standards. The National Highway Development Programme is the largest active infrastructure program, aiming to upgrade 54,000 kilometers of highways with funding from the World Bank, Asian Development Bank, and the Japan Bank for International Cooperation. The project includes some flagship achievements like the Golden Quadrilateral, which was completed in 2012 and connects the four biggest metropolitan areas of Delhi, Mumbai, Chennai, and Kolkata.

The nation’s rail network, the world’s fourth largest, has also suffered from deterioration. The government aims to build 25,000 kilometers of new lines by 2020, yet only 1,750 kilometers have been added from 2006 to 2011. In 2009, Indian Railways released its white paper, “Vision 2020,” that outlined plans to build regional high-speed rail projects and modernize rail stations. Its marquee project, the Dedicated Freight Corridor, was first proposed in 2005 and aims to build six extensive freight lines.

But such large-scale projects have encountered myriad setbacks, dominated by the problem of land acquisition. A legacy of colonial rule, the country’s 1894 land acquisition law allowed the state unchecked power to appropriate private land for public projects. The powers were widely abused, resulting in fierce resistance by farmers. While a new land law passed in August 2013 aims to rectify the problem, industry participants are skeptical. India’s rail budget, which is separate from its federal finances, has also become a platform for political opportunism rather than a financial necessity.

Ports and Airports: India has thirteen major ports and sixty smaller ones that handle 95 percent of the country’s external trade by volume and 70 percent by value. They suffer from cumbersome customs and inefficiency, and new projects face a lengthy list of administrative and environmental clearances that can take up to five years before construction begins. Tariff issues have also severely hampered private investment appetite for the sector, although the Ports Regulatory Authority Bill of 2011 began to address some of these concerns.

India’s aviation sector has also developed significantly. Passenger and cargo traffic are projected to grow at more than 15 and 20 percent over the next few years, respectively, according to the Ministry of Civil Aviation. After privatizing airports in Delhi, Mumbai, Hyderabad, and Bangalore in 2006, the government decided to introduce private ownership of six more airports in September 2013, allowing bidders to enter a private-public partnership with the state-run Airports Authority of India. But labor unions and India’s beleaguered airlines have opposed the move; in October 2013, thousands of AAI employees began a nationwide hunger strike.

Urbanization and Mounting Needs

With India’s rapid urbanization and burgeoning middle class, the need for better infrastructure is pressing. Some 590 million people will live in cities by 2030, and could account for 70 percent of Indian GDP, according to a McKinsey report. Yet India’s administrative structure was built to serve two tiers of government—the center and the state—leaving municipalities with chronic capacity constraints, writes Rajiv Lall, executive chairman of one of India’s largest infrastructure lending firms.

The problem could be draining its growth; project bottlenecks cost the Indian government at least 2 percent of GDP annually, according to McKinsey. Compounding the trouble is official corruption, which curbs the returns on public-private partnerships; a UN report [PDF] found that PPPs in India’s roads and power sectors are most prone to graft. Some estimates suggest that India could suffer a loss of $200 billion, or around 10 percent of its GDP, in fiscal year 2017 if current trends continue.

Financing and Foreign Investment

Historically, the public sector financed infrastructure spending almost entirely. Today, India needs $1 trillion for its infrastructure, with half of that expected to come from private capital. In 2010, India partnered with the United States to launch the $10 billion dedicated Infrastructure Debt Fund.

But the country still faces an enormous funding shortfall that has most recently been filled by its neighbors. In early 2014, China offered to finance 30 percent of India’s targeted infrastructure plan—an offer that, if accepted, would mark its largest single foreign investment in infrastructure. The offer is contentious, given Delhi’s fraught history with Beijing; India has in the past refused Chinese investment over national security concerns. It has also competed with China over growth, juggling an uneasy rapport of rivalry and partnership. Before Chinese President Xi Jinping’s first official visit to India in mid-September 2014, India expected a pledge of $100 billion investments. However, China ultimately made a more modest commitment of $20 billion over five years, primarily dedicated to the modernization of India’s railway and the development of two industrial parks.

Conversely Japan, which has enjoyed cozy relations with Delhi, has emerged as a robust investor. Two-thirds of the Delhi metro was financed through a loan from Japan International Cooperation Agency, which also funded more than half of the $7.7 billion Delhi-Mumbai Dedicated Freight Corridor project. Japan also contributed to the Delhi-Mumbai Industrial Corridor, as well as city road and urban projects. Prime Minister Shinzo Abe continued the flow of funding in early September 2014, during a five-day visit by Modi, with a pledge of $33.8 billion to fund various infrastructure needs over the next five years—a deal that could prove lucrative for Japan’s high-speed rail companies, which face competition from Chinese counterparts hoping to enter the market.

While the United States has policy tools in place to promote investment in India, its commitments pale in comparison to those made by the world’s second and third largest economies, writes CFR’s Alyssa Ayres. In late September 2014, Modi made a landmark visit to the United States to meet with both President Obama and top American business leaders with the intention of restoring confidence in India’s economy and attracting foreign investment.

Yet challenges for attracting foreign direct investment (FDI) remain. Despite the major victory for Modi’s party that many view as a mandate for sweeping economic reform, FDI remains politically divisive, writes the University of Virginia’s Sonal S. Pandya. Rigid FDI policies had been a significant hindrance until the government liberalized them in 2005, allowing 100 percent FDI in a broad range of sectors and expediting approvals. The U.S.-India Business Council recently compiled a list of initiatives, including a resolution to outstanding issues around the civil nuclear deal and an increase in FDI, that would help the United States hit its target of $500 billion per year in bilateral trade. But high inflation and interest rates have recently driven domestic and foreign firms away from long-term projects. Commercial banks hit their exposure limits for the sector, and have even been discouraged from investing further by the Reserve Bank of India.

The private sector invested $225 billion—or roughly 12 percent of GDP—in India’s infrastructure between 2007 and 2012, much of it through PPPs, which have proliferated. Yet these projects have suffered myriad dysfunctions due to poor structure. In 2013, the London-based private equity, infrastructure,and debt management firm 3i, which has the world’s largest India-dedicated infrastructure fund, exited all its portfolio companies in the country after investments failed to meet investor expectations. India, which barely has a municipal bond market, also needs to reform its capital markets to create a source of long-term debt, experts say. But a recent ban by the Reserve Bank of India on bank purchases of new infrastructure bonds has handicapped new Prime Minister Narendra Modi’s efforts of raising funds through the bond market.

Prospects

India’s growth story has often been compared to that of China, which has tapped into domestic savings and foreign investment to build its vast infrastructure. CFR’s Ayres notes that India’s reforms came a decade later than China’s, while others point to the disparity in political systems. “A lot of people point out the difference between democratic and authoritarian structures, and what those do and don’t afford,” says Kale, who adds that in the case of electricity, the problem is not Indian democracy but Indian federalism. “In China, the electricity sector was initially very centralized, and regional grids corresponded to techno-economic boundaries. In India, much of electricity development has been tied to federal boundaries and a political calculus.”

For now, the government has focused on clearing the project jam. In the summer of 2013, a committee formed by former Prime Minister Manmohan Singh fast-tracked regulatory approval to 125 previously stalled projects worth $64 billion. Modi’s new administration appears to have continued such efforts, with central bank governor Raghuram Rajan saying in early September 2014 that the government was focusing on the implementation of stalled projects that would help inflation and income. “In India, if you are looking for grand, big picture reforms it may take some time coming,” Rajan said in a speech. “But in terms of decentralizing, in terms of doing the small stuff which adds up to the big stuff, I think that is already happening.” Research from the Economist Intelligence Unit predicts that infrastructure spending and expansion of the lower middle class will buoy GDP growth in the next few years, achieving 4.5 percent in 2014 and rising to 5.7 percent by 2017.

“India’s been transformed in the last decade; there’s no question about that,” says Ayres. “But most people in India would feel that there’s a lot more to do, and infrastructure is central to creating that twenty-first century India and making sure that it’s a place that’s accessible for everyone.”