The Question Marks And The Stars

All infrastructure sectors in the economy are similar in some respect. They have long gestation periods, huge investment requirement, high construction and development risk, very low operational risk and are financed on project financing basis. However, in spite of these similarities, not all the sectors are equally attractive to investors. When the country needs balanced infrastructure development, the government has to subsidise the projects that are unattractive to investors. The subsidy could be explicit like low interest debt, equity investment etc, or it could be implicit like tax-exempt status, government guarantees, assurance of fixed rate of return etc. The lesser the stand-alone commercial viability of a sector, the higher the amount of resources that the government needs to commit in the form of an implicit subsidy to attract investors.

 

Infrastructure projects can be classified on the basis of two dimensions of implicit resource commitment necessity from the government and investor attention into infrastructure cash cows, stars and questions marks. Infrastructure cash cows, as the name itself implies, dont need subsidy from the government. In contrast, they generate surplus cash for the government. The stars, though highly attractive to the investors, require commitment from the government in terms of an implicit subsidy. The question marks do not find investor attention and require very high support from the government.

Telecom is a good example of an infrastructure cash cow. Though the overall investment requirement is large, investment here is modular. The actual need, therefore, is likely to be in tranches and except for initial hitches is likely to be financed easily. Also, the telecom sector generates upfront resources through licence fees. Investor attention too is immense. Inherent profitability is the highest.

Power, on the other hand, belongs to the star category it does not have the problem of not finding investor attention, though the fund requirement is higher. In all probability, power is the easiest sector all over the world in terms of financiability and the one with the lowest risk. The technologies are proven and stable, there is immense demand-supply gap, and there are no problems inherent in distribution to small end users, especially if generation and distribution are unbundled. Had it not been for the problem of state electricity boards, this sector would have been a potential cash cow.

Roads is a question mark the investment requirement for this sector is huge and investor attention is meagre. The gestation period for a road project could be as high as eight to 10 years, and the profitability is highly dependent on the developers ability to project the vehicular traffic. There is user resistance to payment of tolls and hence, uncertainty is high. The world over, it has been difficult to garner private interest in roads. Even in the US, 85 per cent of the road projects are financed by the government. In reality, there have been very few stand-alone road projects.

Local municipal infrastructure like water supply, drainage and waste disposal systems are most likely to be question marks. Though the fund requirement here is likely to be immense, it is unlikelythat users would be willing to pay economically justifiable costs, and investorsare mostlikely to shy away from such projects.

Infrastructure cash cows like telecom should finance the stars and question marks. What is essentially suggested is the bundling of sectors at a macro level. This concept of bundling to attract investor attention is not new. However, most examples in this regard are cases of intra-project cross subsidisation. Resource movement and cross-subsidisation across the sectors has not been tried so far. In India, the government will be receiving huge amounts in the form of telecom licence fees. These funds should be earmarked for subsidising the projects in other sectors where thereturns are not to commercially acceptable levels.

It can be argued that the telecom licence fee may not be enough to fin-ance road, local utilities and po-wer projects. However this may not be so. This is because the projects are not to be financed in totality, but only to the extent of shortfalls to boost the internal rate of return (IRR) to an acceptable level.

The projected investment requirement in the road sector for the next 15 years is Rs 200,000 crore. Assuming that the IRR for a road project, without sops and tax holidays, comes to about 10 per cent and the requirement for the project to be bankable is 22 per cent, the subsidy requirement is, to the extent of shortfall of 12 per cent, aggregating to Rs 24,000 crore. The implicit subsidy here could be either financial or could be in the form of support.

Investment needs of the ports sector is Rs 50,000 crore. The IRR requirement for ports can be taken to be 18 per cent. An analysis of the investment required and projected cash flows shows that the IRR for a port without any subsidy averages 6 per cent. Thus, subsidy of 12 per cent of the investment requirement has to be provided for, amounting to a sum of Rs 6,000 crore at the aggregate level. The subsidy can be provided in the form of site development activities apart from offering financial instruments and guarantees.

Similarly, for power projects, an analysis done for a 100 mw combined cycle naphtha-based plant shows that the extent of government support in the form of state government guarantees, guarantees on payments in the form of escrow and L/C, and IT benefits comes to Rs 48 crore over the PPA term of 15 years. This translates into a subsidy of 0.25 crore per mw, at current prices. Given the additional requirement of 80,000 mw of capacity, the implicit subsidy required from the government is Rs 20,000 crore.

Thus the total subsidy requirement for power, ports and roads comes to Rs 50,000 crore, while the telecom licence fees for cellular services alone would amount to Rs 40,000 crore. In India there have been start-up problems in the telecom privatisation process, and the licence fee figures which might be realised eventually may be considerably less than the figures quoted in the bid, especially for basic services.

However, if one considers that the lucrative long distance and international telephony will be privatised eventually, the government is likely to earn considerable licence fees income. Thus there is enough surplus available from the telecom sector for meeting the requirements of other sectors.

An important point to note is that this framework suggests a snap-shot analysis and the positions of various sectors may change from one quadrant to another with time.

For instance, once the SEB reforms are through and the power tariff structure is reorganised, this sector can become a cash cow. Similarly, roads can generate surplus cash after 15-20 years time when the investment on the roads being constructed now is recovered by charging a cess on the tolls.

(The author is an analyst with the advisory services group of CRISIL)

The lesser the stand-alone commercial viability of a sector, the

higher the amount of resources that the government needs to commit in the form of an implicit subsidy to attract investors