Investments Envisaged and Modes
Infrastructure is one of the biggest bottlenecks in the economic development of India. In spite of continued government focus on infrastructure, the supply has not been able to keep speed with the demand. For example, the 2% of the road length (National Highways) carry 40% of the traffic, only 12% of the roads are four lane among the National Highways, peaking energy deficit is 14% while the energy shortage is 11%, average speed of passenger train is 50 kmph while that of freight is 22 kmph, and pay load to tare ratio is more than 2.5. These numbers speak for the scope of further improvement that may be possible in Indian infrastructure.
Considering this need, the investment required during 11th Five Year Plan (2007-12) was envisaged to be USD 500 billion as against the previous plan (2002-2007) of USD 226 billion at 2006-07 prices. To spur the growth in infrastructure, the investment during 12th Five Year Plan (2012-2017) has been envisaged at USD 1 trillion. At an aggregate level, it is expected to drive a growth rate of 9% while keeping the GCF between 9.5% and 10% of the GDP.
Sources of funding
During 11th five year plan, 30% of the total investment in infrastructure was expected to be bridged through private sector participation (Figure 1). The proportion of investment from private sector varies across sectors, primarily due to variations in the risk perceptions, capacity of the proponent institution to attract private sector investment, and existing institutional and regulatory frameworks. Similar variations have also been experienced across different geographical regions.
During the 12th FYP, the share of private sector investment has been envisaged to be 50% as against 30% during the previous plan. This is possible only by attracting foreign investments successfully and releasing some of the constraints on various funds and bank with regard to their exposure to infrastructure project. Over the last four years, banks’ exposure to infrastructure lending has grown nearly fourfold. The infrastructure credit as a proportion of the total credit has increased from 6% to 9.5% during this period (March 2005 to March 2009). For banks, this has increased the credit risk substantially including asset liability mismatches (which can increase liquidity and interest rate risks), credit risk, implementation delays leading to cost/ time over runs, concentration of risk due to execution of many similar risk profile projects by an agency/institution.
Foreign Direct Investment (FDI): Opportunities and Restrictions
Foreign Direct Investment (FDI) plays a vital role in augmenting a country’s fiscal resources. During the last decade, FDI has grown for all the three (developed, developing and transition) economies. Developing nations attracted 27% of the global FDI flow in 2007, with India’s share pegged at about 21%. India was ranked as the second most favorable nation according to an FDI Confidence Index ranking in 2007.
South East Asian countries represent a good example of the impact FDI has on a country’s growth. FDI as a percentage of GFCF (Gross Fixed Capital Formation) was 19.1% for Malaysia during 1990-96, propelling the country’s average GDP growth rate to 9.5%.For the Philippines, telecom and energy sectors experienced rapid growth induced by FDI. Similar was the experience with other countries, except Thailand.
Thailand preferred to finance most of its infrastructure investment through private debt, helped by the country’s high savings rate of 36%. However, once the East Asian crisis erupted, Thailand has to encourage FDI to check falling currency. This also helped the economy grow at 7.1% in 2003 with FDI contributing to 17% of gross fixed capital.
The Indian infrastructure sector is slowly attracting interest from international investors. The contribution of FDI towards infrastructure in India has increased from 13.3% in 2007 to 30.7% in 2009. This is significant, especially, in the period of the global financial meltdown. However, India’s FDI flow as a percentage of GFCF stands at 5.8%, much lower than the developing economies’ average of 12.6%, as also to that for the world economy average (14.8%) during the period.
During 2006-09, the FDI inflow in India has primarily come in the service sector (23%), computer software and hardware (10%), telecommunication (8%), housing and real estate (7%), construction (6%), power (4%), and automobile (4%) through the FIPB, M&A and RB routes. There has been little reinvestment.
The target annual investment from private sector would be nearly ten folds of what has been achieved during the 11th five year plan (2007-2012) of USD 1.3 billion, attracted by electricity, roads, telecom, ports, railway and airports.
In order to attract this kind of investment, Government of India through Department of Industrial Policy and Promotion (DIPP), Ministry of Commerce and Industries releases circulars and regulation guidelines on a regular basis to enable private sector participation.
FDI can come into India through following mechanisms:
a. Automatic route: Under this route, no government clearance is required for any investment limit as long as the investments are within the sectoral limits specified by the government. The regulatory norms only specify that Indian firms have to inform local RBI office within 30 days of receiving the remittance.
b. FIPB route: Investments which do not qualify under automatic route require government approval. This approval is provided by Foreign Investment and Promotion Board (FIPB). FIPB conveys its decision to the applicant within 4 to 6 weeks. Thereafter, an application is filled with RBI.
c. CCFI route: Investments outside automatic route and above Rs 6000 million require approval of cabinet Committee of Foreign Investment (CCFI).
A brief of the prevalent FDI policy is bulleted below:
Ø After the policy changes in February 2009, many sectors in manufacturing are open to 100 % FDI under the automatic route except defence production where it is capped at 26 %.
Ø FDI is currently allowed only up to 49 % in scheduled air transport services or domestic passenger airlines.
Ø Broadcasting services allow 49 % similar rules. Uplinking of non-news television channels is the only broadcasting service permitted to have 100 %FDI after clearance by FIPB. Majority foreign equity is not allowed in cable television networks and direct-to-home (DTH) operations. FDI is allowed only up to 26 per cent in print media.
Ø FDI is allowed up to 74 %in financial services such as private banks. Insurance, however, can get FDI only up to 26 %. Minority foreign equity up to 49 %is permitted in asset reconstruction companies (ARCs), stock exchanges, depositories, clearing corporations and commodity.
Ø In telecommunication services (both basic and cellular) although FDI up to 74 % is allowed, only 49 % is allowed under automatic route with the rest requiring approval from FIPB.
Ø 100% FDI is permitted through automatic route for townships, housing, built-up infrastructure and construction development projects (which would include, but not be restricted to housing, commercial premises, hotels, resorts, hospitals, educational institutions, recreational facilities, city and regional level infrastructure). These are subject to following restrictions
o In case of development of serviced housing plots, a minimum land area of 10 hectares
o In case of construction-development projects, a minimum built-up area of 50,000 sq.mts
o In case of a combination project, any one of the above two conditions would suffice
Ø FDI in industrial park is permitted up t0 100% subject to other regulations
Ø FDI in Infrastructure companies in Securities Markets (stock exchanges, depositories and clearing corporations) are permitted up to 49% subject to SEBI Regulations
Ø In power sector, 100% investment through direct route is permitted in generation and transmission
In terms of instruments, equity shares fully compulsorily and mandatorily convertible debentures, and fully compulsorily and mandatorily convertible preference shares subject to FEMA (Foreign Exchange Management Act 1999). Other types of preference shares/debentures are treated as debt (those issued on or after May 1, 2007). Deposit receipts (DRs) and Foreign Currency Convertible Bonds (FCCBs) are also used by Indian firms. GRs could either be AGR or GDR depending on their trading stock exchange. There are also limited reissuance of ADRs/GDRs permitted under two way fungibility scheme under which a stock broker in India can purchase shares of an Indian company from the market for conversion into ADR/GDR based on instructions received from overseas investors, subject to other guidelines.
Restrictions for Indian pension funds to invest in infrastructure
Investment in infrastructure is one of the heavily debated topics among policy makers especially after the bubble burst of 2000s. Spreading asset allocation of pension funds to direct infrastructure investment has been seen as exposure to market volatility, inflation, and interest rate risk across various countries.
However, may pension funds see infrastructure as a lucrative market in the long run and hence considering investing in the pension funds. Some of the examples of investments by pension firms include Ontario Municipal Employees Retirement System (OMERS) in Canadian economy, CalPERS in USA, and APG in Dutch economy.
In India, pension funds are yet not allowed to directly invest in the infrastructure sector due to the risks infrastructure sector bears. A systematic analysis of the risks need to be carried out to ascertain and suggest methods by which pension funds can allocate their investments better and at the same time infrastructure can receive another source of funding. The methodology section discusses some of the methods which can employees.
Bond market and secondary markets
Underdeveloped bond market is one of the constraints that infrastructure financing faces. Several committees have recommended development of a mature bond market.
To meet the demands of infrastructure financing, Deepak Parekh committee has recommended setting up of a Rs50,000 crore debt fund for infrastructure development, with around $2 billion (Rs9,400 crore) sourced from foreign exchange reserves. This would also reduce the burdens of banks and allow them to manage their asset liability mismatch better.
