Why the govt shouldn't just privatise factories but infrastructure too

India should consider a reverse Build Operate Transfer (BOT) model wherein the government finances a project on the EPC basis, and then when it's ready, it auctions it off to the private sector

Last week I wrote about how risk capital for building capital-intensive infrastructure wasn't a good idea because it can't absorb losses and that taxpayers should finance infrastructure.

I had also said that we should perhaps consider a reverse Build Operate Transfer (BOT) model wherein the government finances a project on the EPC basis, and then when it's ready, it auctions it off to private sector operators because they would operate it more efficiently.

That's to say, it's not just factories that the government should privatise but infrastructure as well. The absence of risk capital will ensure no ILFS or Adani-type disaster.

I should mention that India is late by 25-40 years in these infrastructure fiascos. It's extraordinary that, when we started down this path in 2005, we didn't look at the Latin American experience of 1978-81 when countries there borrowed short-term money to finance long-term investments in infrastructure.

Mexico was the first to default in 1982, followed by nearly all the other countries in the region. Latin American growth collapsed for the rest of the 1980s. The moral of the story: don't use short-term funds to finance long-term investments just because cheap money is available.

Gautam Adani did no more than tap into the post-2008 tsunami of dollars. The money was there for the taking, and he took it. Clearly, foreign lenders, too, have been remiss.

Soon a mismatch between short-term debt and long-term projects appeared. It was only a matter of time before the debt-equity ratio went completely out of whack. The regulators didn't act proactively. Globally, too, they often don't. They need to be held accountable.

Anyway, getting back to the reverse BOT model, we have seen it work in the case of many public sector companies, albeit that was not the intention. Air India is the latest of these.

The difference between that and my proposal is that for the new assets, the babus and politicians will not be able to destroy their value if they are allowed to run them. On capital costs, we have to assume they will do what they do.

For the sake of argument, consider a 100-kilometre stretch of highway. Suppose it needs an investment of Rs 10 per kilometre, or Rs 1,000. But its economic value after construction is regarded as being Rs 1,00,000 over five years. This is what the government must aim to receive as auction proceeds.

The only question then would be what auction model to follow. This is the crucial detail which can and should be worked out quite easily. I think the second price auction would work best—more on this next week.

To be sure, the capital needed to buy the road would be risk capital. But this risk would be very different from the type we get in India for constructing such things to mitigate which political friends are needed.

The main benefit is that the auction would have created a market for infrastructure assets, which can be bought and sold by purely private entities. At present, no such market exists. More than any other effort by the government, it is this that will develop a long-term bond market.

But what would happen if the reserve price wasn't reached? That's the government's risk, but a small one.

This is also the risk — of not finding a buyer for his assets — that Mr Adani faces because, ultimately, he has to find the money to service and liquidate his debt. And this could test the government's nerve in the months to come.