Business Daily from THE HINDU group of publications
Tuesday, Sep 19, 2006
Industry & Economy - Infrastructure
Infrastructure Financing Accountability is not axiomatic
One of the burdens that North Block has to shoulder as the guardian of the nation's books-of-accounts is to balance the demands placed on public resources today with the liabilities that may have to be borne by future generations. For decades, the overspending and the fiscal deficit proved a drag on the economy as the government crowded out the private sector in its urge to spend more to meet its liabilities.
That vicious cycle has been partly broken with the deficit now hovering around 4 per cent of GDP not so much by belt-tightening as due to a surge in revenues and a decline in the revenue deficit.
With an average GDP growth of around 7 per cent the past few years, tax revenues have been buoyant; the gross tax-GDP ratio has been steadily rising since 2003-04 from 9 per cent and the Budget estimates it to scale 11 per cent if the present growth rate continues.
This robustness, more than a decline in government spending, has filled up the fiscal deficit somewhat, creating contrary responses from various policymakers. North Block would like to reduce the deficit even further and never fails to throw the idea of fiscal responsibility at other ministries that would prefer a more expansive government. The Human Resource Ministry has come out clearly in favour of it, the Planning Commission also did so, then retracted somewhat.
The Planning Commission Deputy Chairman, Mr Montek Singh Ahluwalia, is no stranger to the Finance Ministry concerns about fiscal tightening but he is in charge of finding resources for the Eleventh Plan and has put his ingenuity to good use. He has suggested a drawdown of the nation's growing forex reserves to help fund the massive infrastructure and other Plan projects.
The SEZ Fever
There is little point in hoping for private sector participation without a more flexible environment for land use and other enabling privileges.
The Special Economic Zone is like a free gift of real-estate and developers cannot run fast enough to the Commerce Ministry with their applications; in effect, a perverse economic incentive is diverting private capital from infrastructure to real-estate development and the Planning Commission and North Block are left wondering how best to manage their respective burdens without much help from the private sector. Is it any surprise that real-estate developers are also queuing up for SEZs? No one is asking what they are going to export.
For the Finance Ministry, then, the prospect appears dismal; the one streak of good fortune, healthy tax revenues, may just disappear as SEZs mushroom, tax exemptions come into play, and revenue losses mount. The Commerce Ministry has gone to some pains at calculating the revenue gains from SEZs to counter the Finance Ministry's calculations of losses on the revenue side. Both sets of figures are projections but it stands to reason that a scheme replete with tax exemptions and holidays will incur revenue losses during the period of the tax privileges.
Pressure on government
But that is in the future. Now the pressure mounts on the government to bear the burden of Plan projects and other schemes that the ruling United Progressive Alliance has dedicated itself to. Mr Ahluwalia has suggested that the country's huge forex reserves, around $160 billion, be used for the purpose instead of lying idle in the RBI's vaults.
Essentially, the government would run up a higher fiscal deficit over the next two years by issuing securities that the RBI would then monetise by picking up those instruments, thus preventing a crowding out of private investment.
The rupee resources obtained by the government would be used to purchase foreign exchange of the same amount. Since the RBI would effectively intervene in the market to release this amount of foreign exchange, the exchange rate would not be affected. The scheme expects a fully imported infrastructure project would augment capacity in exchange for a drop in reserves. Mr Ahluwalia holds the "non-disruptive" nature of this scheme to be "axiomatic."
Predictably there has been silence from North Block and Mint Street on this proposal. The central bank has its own ideas of the use of forex reserves knowing full well that a great part of it is "hot money" and therefore volatile.
The axiomatic scheme places a great onus on a central bank that would rather allow the private sector to use the reserves for its productive use. If the Second Tarapore Committee has its way, the spending limits for corporates, banks and individuals will rise dramatically.
External Commercial Borrowings and global acquisitions allow for the same kind of productive development through imports though without the participation of government. The risk of failure and burden of redemption of global debt eventually falls on the nation but the results so far seem to augur well; increasing levels of productivity and the globalisation of Indian firms. If it is government that has to initiate infrastructure growth, policymakers could do worse than look at ways of augmenting its resources through divestment. It is also an axiomatic principle that, if needed, households sell something to buy something else. Prejudice and not economics stalls the sale of minority stakes in PSUs when in fact, that is the most painless resource-raising technique.
Tap the Banks
Then again, the banking sector, as financial intermediary, could be the other vehicle for funding infrastructure. To this end, a series of reforms would be needed to enable banks augment their capital. The Second Tarapore Report has pointed to this need in the context of fuller convertibility but the need for freedom for banks to strengthen their capital base in line with Basel II norms can hardly be denied any longer for other, more critical needs.
Diluting government ownership in public sector banks from 51 per cent to 33 per cent, as the Second Tarapore panel recommends, is not enough to get banks the muscle for large project financing. So far the RBI's regulations have been inspired by financial stability often at the cost of growth promotion. The next series of reforms must allow banks the flexibility to diversify their investment portfolios; increasing exposure limits to infrastructure projects from present levels would get the public sector banks actively engaged in the very plans policymakers are seeking resources for. As A. Vasudevan pointed out in "Finding funds for ambitious plans" (Business Line, September 14), permitting banks a greater play in the corporate bond market would also help in infrastructure growth.
Given the nature of demands, infrastructure financing or even social sector development requires innovative initiatives, perhaps a mixture of domestic and foreign investment through the intermediation of the banking system that has organically evolved into a major player in growth so far in the service sector. The temptation to fall back on deficit financing is strong but for more than one reason it ought to be resisted not because of some fetish about balancing the government books so much as the weight of history; most government-funded projects have been marked by inaction, profligacy or both. Jean Dreze's review of the National Rural Employment Guarantee Act in The Hindu of September 12 exposes just about every party's inaction on this much-vaunted programme.
Project implementation still dogs most officially funded programmes; as one time chief evaluating officer in the IMF Mr Ahluwalia should know that there is very little pressure for accountability.
No system is flawless but shareholders can sack the chief executive for non-delivery or shoddy performance; voters can run an incumbent out of office. But that shoddy road or money frittered away, will still disrupt the most axiomatic principles of financing.
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