Challenges facing India’s Infrastructure Sector – Part II

In my last post, I had written about the challenges faced by infrastructure sector in India. If we were to look into the reasons behind the challenges in India’s Infrastructure sector, we see that the problems can be broadly categorized into structural or procedural in nature.

Structural reasons:
  1. Faulty incentives: Government organizations as well as the concessionaire are wrongly incentivized while implementing the infrastructural projects. Government contracts are generally awarded on the basis of lowest price and this encourages private players to undercut each other in prices for winning the contracts, thus resulting in poor quality bids and shifts the focus from long term viability of the project to short term gains, while transferring the risk to debt owners or the tax-payers.
  2. Oligopoly of project proponents:  Infrastructure projects require very high capital contribution and bank funding. Since India is still young in terms of numbers and complexity of infrastructure projects executed, at present we find only a handful of companies bidding and being awarded with projects in the country leading to a situation of “managed competition” where projects theoretically can be “distributed or shared”.
  3. High cost of funding : High cost of borrowing both from bank loans and bonds, has off late increased reliance of companies on ECB to reduce cost, which exposes the project to currency volatility, underestimates cost over the project period and increases the risk of correctly forecasting cost of borrowing subsequently when refinancing.

Procedural reasons:

  1. Underassessment of risks: The quality of data/ information on which key assumptions are based have a great role to play on the integrity of the project. Underassessment of risks due to faulty assumptions, allows the bidder to quote low price for end users charges, which after a while may not be sustainable as can be seen in the cases mentioned in my last article, leading to situations where the concessionaires attempt to re-negotiate contract, citing some excuse, often soon after being awarded the project. Government agencies with the responsibility of evaluating the bids, need to take a objective view of the nature and severity of risk involved. On solution could be that the Government agency entrusted with the implementation of the project could fix boundaries for various parameters including end user charges, so that bids are within band in which bidders compete on the basis of better understanding and forecasting of risks, efficient use of resources and quality of management, rather than reckless gambling.
  2. Reduction of promotor’s stake in risk and reward:  As is the international practice, in project finance/ PPP projects, some of the consortium members and equity contributors are also providers of goods and services for execution of the project. Such companies always have some room to recover their investment through innovative pricings of sub-contracts much before the cash waterfall would allow payback to equity providers. If such a thing does happen, it leaves the founder companies with virtually no risk and creates ground for them to be opportunistic during subsequent bargaining for revision of prices.
  3. Delay in fixing accountability: The slow judicial system in the country causes delays in enforcing liabilities in case of mistakes committed by companies or when companies try to put themselves at an advantageous position vis a vis other stakeholders. Delays can cause erring parties to get away with playing around in the grey zones of the contractual agreement and passing on the burden to the end users and tax payers
All these factors point to the need for a more favorable environment, with institutions, mechanisms and improved governance standards to bring in the required efficiencies for allowing PPP to evolve and mature.

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