Opinion | Maximizing India’s development finance
Only by combining resources will it be possible to achieve the necessary levels of financing
The Fourth Industrial Revolution, along with internet penetration and access to smartphones, has changed the outlook of people everywhere. Everyone can see how others live and this has raised their aspirations and expectations. People are demanding improved infrastructure to meet their aspirations.
This aspiration is particularly acute in the developing world, given the poor infrastructure and huge development financing needs. It is estimated that infrastructure investments needed in energy, transport, telecommunications, water and sanitation, education, and health projects will amount to more than 5% of gross domestic product (GDP) in developing countries. Meeting the financing gap needed for infrastructure services will be one of the biggest challenges in development. Unlike in the UK and the US, in developing economies, nearly 70% of the funding for infrastructure projects comes from the government budget, 20% from private players, and 10% from multilateral development banks. In the developed world, the financing mix of infrastructure projects is very different, with less than 40% being funded by governments and the private sector contributing more than 50% of financing needs.
While the infrastructure financing gap is huge in the developing world, the potential for attracting private investment for infrastructure projects is also huge. The basic traits of infrastructure projects, such as market size, long-term steady revenue stream, and investment returns that exceed inflation, make them attractive for institutional investors. The funds managed by institutional investors in Organization for Economic Cooperation and Development (OECD) countries exceed $100 trillion. Their allocation to emerging-market infrastructure projects is tiny.
Many developing countries have launched programmes to attract private investments into infrastructure projects. India has experienced a rapid increase in the number of public-private partnership (PPP) infrastructure projects during the last two decades. The government has established institutional structures in the ministry of finance and line ministries to scale up PPP projects. A fast-growing economy and public-sector capabilities to prepare, procure and implement PPP projects have played a key role in creating markets and improving efficiency gains. The electricity and road sectors have attracted the lion’s share of PPP investments in India. This is just the start (Ejaz Ghani, Arti Grover Goswami and William R. Kerr, Highway To Success; and Spatial Dynamics Of Electricity Usage In India, World Bank). India’s energy efficiency market, estimated to be more than $12 billion per year, is one of the largest untapped energy-efficiency markets in the world. Ports and railways have also attracted investment, but at the lower end.
Commercial banks have dominated the financing of infrastructure projects. This amounts to the government transferring a huge amount of risk from public to the private sector. With the structure of financing such that there is heavy reliance of private financing on the public sector and with heavy termination clauses included in PPP contracts, the government is potentially exposed to fiscal risks. The number of foreign partners financing infrastructure projects have been few in the past.
India and most of the developing world face a twin challenge—closing the infrastructure financing gap and changing the composition of financing. Given rising global macroeconomic and trade concerns, changing the composition of financing is as important as maximizing infrastructure capital. Changing the composition of capital flow also has the potential to increase the efficiency and sustainability of public finance and infrastructure projects.
Looking to the future, there exists a huge potential for creating markets and improving the preparation and regulation of PPP projects in areas such as time taken to prepare projects, contract management, risk management, socioeconomic impact, affordability, and bankability of projects, and meeting the strategic importance of development goals. While commercial banks will continue to be an important source of infrastructure finance, capital markets need to play a bigger role, given the increased demand for long-term sources of finance for infrastructure projects. Bond markets, especially local currency bond markets, will be critical to filling the infrastructure-investment gap. There is also a need to avoid currency mismatches from borrowing in foreign currency for projects that generate revenues largely in local currency. More fiscal reforms could also generate more revenues to bridge the infrastructure financing gap. Taxation will play a key role in incentivizing investment and ensuring that the proceeds of investment are redistributed and reallocated in line with sustainable development priorities. A lot more regulatory and institutional reforms are also needed to make infrastructure projects more attractive for private investors.
Developing countries have overcome many of these challenges with outstanding success in road and energy projects. Many infrastructure projects give a social return that is greater than the benefits to individuals paying user fees and this makes it more challenging to monetize the benefits of infrastructure projects and create cash flows for potential investor. Rural road networks, investments in education and health, and women-headed small enterprises are examples of projects that have greater social benefits than the cash flows they can generate. A second generation of infrastructure projects is emerging that is presenting a host of untapped potential.
No country can sustain growth and reduce poverty without maximizing development finance. Maximizing finance for development, from billions to trillions, will not come from a single financing instrument. Only by combining resources—international and domestic, public and private, corporate and philanthropic—will it be possible to achieve the necessary levels of financing. Even then, policymakers will need to improve expenditure policies to target resources to people who are most in need. The challenge is to increase both the scale and impact of financial resources, improve linkages, and build partnerships. More can be done to strengthen the framework and tools needed to engage the private sector and maximize finance for development.
Ejaz Ghani is lead economist at the World Bank.
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