New Paradigms

Innovations in infrastructure development

Professor G. Raghuram, Director, Indian Institute of Management, Bangalore

Even as India looks to step up the pace of growth of its economy and provide a better quality of life to its citizens, infrastructure remains a major bottleneck, both in quantity and quality.

Infrastructure fundamentally means a structure that supports from below. It is a common resource for all developmental and even basic quality of life activities. Society should be able to take the availability of such resources for granted. It is a structure that has a multiplier effect on the economy. Such a structure should facilitate not only economic development, but also be socially and environmentally sustainable. Since infrastructure supports a wide range of activities, it should be of appropriate quality and developed in a timely manner with the right investment.

Challenges

Infrastructure requires high investment costs and exhibits economies of scale, leading to natural monopolies. Continuing examples are Indian Railways, some state electricity boards, etc. Infrastructure often uses a key “national” resource and exhibits a public cost. It could be a large or linear stretch of land, or an environmentally sensitive space like a coastline and spectrum. The benefits of infrastructure accrue not only to direct users, but to indirect beneficiaries as well.

The above principles point to what are known as market failures. When there is a market failure, regulation becomes essential. Many democratic societies believe that if the government is the primary actor in the design, development and delivery of infrastructure, regulation as such may not be essential since governments are accountable to the citizens and have to be periodically voted into power. This can reduce the transaction cost and governance overheads. However, governmental structures, especially in a country like India, have not been able to keep pace with the infrastructure demands. Infrastructure development today needs to leverage management capability, regulatory and legal capability, technological advances, international collaborations and financial resources. In short, an ecosystem with greater “incentive compatibility” is required.

PPPs: A new organisational form

Subsequent to liberalisation in the early 1990s, the need for greater focus on infrastructure was felt. Given the perceived “incentive incompatibility” in our governmental systems, a new organisational form was innovated; public-private partnerships (PPPs) emerged as the major vehicle for infrastructure development.

The government has attempted to step back from design, development and delivery, and redefine its role as a facilitator and regulator. This has created the space for a variety of stakeholders to step in and take the responsibility of addressing the various challenges in infrastructure development. These include the political system, bureaucracy, and leadership and management of developers, contractors, financing agencies, insurance agencies, media, the judiciary and lawyers, and think tanks. There has been significant innovation in the way PPPs have been conceptualised, engaged with and regulated.

Innovation areas

The following are the key areas of innovation for achieving “incentive compatibility”. These innovations have been discussed under eight heads. We present seven of them along the project life cycle starting from project structuring till post-project ownership. The eighth, pertaining to the regulatory and dispute resolution framework, is applicable throughout the life cycle. Some of the new innovation areas are risk assessment and management during appraisal, sourcing of funds from institutions beyond the government, post-project ownership, and the creation of a regulatory framework. In the other areas, innovation is in the changing focus and attributes.

  • Project structuring: This is the most fundamental aspect of infrastructure development, wherein we decide what set of activities constitute a project. This should enable a match between what needs to be done (demand side of infrastructure) and what competencies are available along with incentives sought (supply side of infrastructure). An appropriate bundling of activities needs to be considered, keeping in view competition, scale economies, specialisation and scope economies, rather than just technological logic. It would also mean judiciously combining consequential non-core revenues with the core revenue. Over the years, we have experimented and learnt what dimensions of structuring should be policy-driven and what can be context-driven. Formats such as build-operate-transfer, design-build-finance-operate-transfer, operate-maintain-transfer and many others have evolved to suit contexts. The projects are executed through a special purpose vehicle (SPV).
  • Appraisal, and risk assessment and management: The structured project needs to be appraised for viability and risks. Over the years, we have moved from just an economic or financial return analysis to a risk-inclusive analysis, which also includes risk management. The risk allocation between the government (authority) and the private party (concessionaire) has changed over the years in a manner that the party that can better bear a risk gets to bear it. For the private party, project risks are contained within the SPV.
  • Funding sources: Traditionally, project funds were sourced from government budgets (taxes and subsidies) and, to an extent, direct revenues. Today, a host of innovative sources including indirect revenues, equity, grants and debt instruments are available that match the risk appetite, have longer tenors and lower interest rates.
  • Tendering and bidding: The documentation and processes have changed to include multiple stakeholders and multiple stages. Similarly, the bid criteria have been experimented with, resulting in greater openness in seeking the most appropriate solution for a given context. Bid criteria such as concession periods, royalties, lump sum payments, revenue share to annuities, and hybrid models have been considered. Further, open competitive bidding has become the norm instead of strategic partnerships, which may not have gone through the required due diligence.
  • Legally tenable concession agreements: We have transitioned from contracts to concession agreements, models for which have been continuously innovated over the past two decades. Greater clarity in agreements has come in with limited scope for interpretation. Going forward, one hopes that legal cases due to interpretation issues would reduce.
  • Project management: Project activities can now be assigned to the authority or the concessionaire depending on the risk bearing capacity. In the early PPP years, land acquisition was considered the responsibility of the concessionaire, but has subsequently changed hands and become the responsibility of the authority. Even here, the extent of land that should be made available at the start of the project has been changing in a manner favourable to the concessionaire. This has brought in greater “ownership” in project management, and increased government accountability and private stakeholding. Over the years, the principles of construction management have changed significantly, though there is room for further improvement.
  • Post-project ownership: There is a need to change the ownership of an SPV. A balance needs to be struck as to when and under what conditions ownership can be changed, without making it either speculative or restrictive. Over the years, we have been open to defining conditions and processes for restructuring, including mergers and acquisitions.
  • Regulatory and dispute resolution framework: Significant innovations have happened here, resulting in new institutions and instruments. Regulatory agencies are being set up to regulate a variety of domains. These include licensing (attributes that define who would be eligible to provide a specific infrastructure), safety, security, tariffs, quality of service and dispute resolution.

Over the past two decades, the focus area of infrastructure has been consistent across political regimes both at the centre and in the states. This has led to consistent innovation to attract private participation, albeit with some (but decreasing) bureaucratic resistance. By 2010, India had emerged as the world’s largest PPP market. The good news is that we are still innovating, including moving out of PPPs where required.

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