Infrastructure Development in India's Reforms

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1 Infrastructure Development in India's Reforms Montek S. Ahluwalia It is a privilege to contribute to this volume honouring Dr Manmohan Singh. I first met Dr Singh in 1970, when I was a very young staff member of the World Bank and it was at his encouragement that I later left the World Bank to join the Ministry of Finance as Economic Advisor. Many years and two other assignments later I returned to the Finance Ministry in 1991, a few months after Dr Manmohan Singh became Finance Minister and thus had an inside view of economic reforms which were to become inseparably linked with his name. It is a manifestation of this linkage that when my good friend Swaminathan Anklesaria Aiyyar, then Editor of the Economic Times, coined the term 'Manmohanomics' to describe the economic rationale of the new policies, it quickly gained currency, as if plain vanilla 'economics' had been irretrievably appropriated by the other side! The five years during Dr Manmohan Singh's stewardship of the Finance Ministry saw a remarkable change in the mind-set of those interested in economic policy. The reforms which were initially seen as an unpleasant though necessary package to stabilize the economy, began to be perceived as the only way of raising India's hitherto modest growth performance to the 'high growth poverty reducing' combination enjoyed by many East Asian countries. It is of course too early to pronounce whether they will succeed in this objective, but the early results are certainly promising. After a swift recovery from the 1991 crisis, economic growth accelerated to an average of 7 per cent per year in the three years ending in , taking the average for the Eighth Plan period, to , to 6.5 per cent which is significantly better than 5.6 per cent in the 1980s. India's relatively closed economy has been made much more open to trade and foreign investment, with none of the negative effects feared by critics, and with every expectation of reaping efficiency gains in future. These successes notwithstanding, there are also some deficiencies which could limit the effectiveness of the reform package. One such deficiency relates to infrastructure development. Acceleration of growth from 5.6 per cent per year achieved in the 1980s to East Asian levels of 8 per cent will generate a massive demand for infrastructure services, such as electric power, roads, ports, railways and telecommunications. Since these services are all non-tradable, the additional demand arising from faster economic growth has to be met by expanding domestic supply in each of these sectors. 1 Furthermore, since growth will in future occur in a more open trading environment, with strong pressures to improve competitiveness, the quality of infrastructure services will also have to improve significantly. Indian industry will not only need adequate power supply, but 1 The term infrastructure is used more loosely in Indian official literature and often includes tradable items such as steel, cement, fertilizers and petroleum products. However 'important' they may be, they are all importable and therefore cannot be a physical constraint on the expansion of the economy hi die same sense as non-tradables. Of course, the dependence on imports may pose foreign exchange problems and this has to be viewed as part of the strategy for managing the balance of payments. The expansion of domestic supply of these items in that context has to be justified as part of an optimal production response to balance of payments problems, taking account of other possibilities of expanding production of exports and other import substitutes. 1/18

2 also high quality power, free of interruptions and voltage fluctuations. Similar upgradation of quality is relevant for other infrastructure services also. The economic reforms must therefore be accompanied by a strategy for infrastructure development which can meet the increased demand for infrastructure services both in terms of quantity and quality. Does India's reform programme have such a strategy for infrastructure development? This paper analyses the approach to infrastructure development adopted in the reform programme and evaluates performance in individual sectors. Some lessons are drawn for the future from the experience thus far. I. STRATEGY FOR INFRASTRUCTURE DEVELOPMENT Infrastructure problems were not the central focus of policy when the reforms began in mid The agenda for reforms in the early years was understandably dominated by crisis management and the need for domestic and external stabilization. The primary focus therefore was on reducing the fiscal deficit to restore macro-economic stability and introducing a package of efficiency-oriented reforms aimed at deregulating the domestic economy, reforming trade and exchange rate policies and liberalizing foreign investment policy. Besides, infrastructure was not a significant constraint on short-term economic performance at die start of the reform programme because there was slack in the system with considerable scope for expanding supplies of infrastructure services in the short run through better utilization of existing capacity. The first articulation of a strategy for infrastructure development as part of the reform programme is to be found in the Eighth Five Year Plan which was published at the end of Contrary to the impression conveyed by many critics that tire reforms relied excessively and unrealistically upon private investment for development of infrastructure, the strategy outlined in the Plan, as the quotation below makes clear, envisaged a continuance of public sector dominance, with the private sector playing only a supplemental role. Since the scale of construction in these areas is very large and these are of direct and immediate benefit to large sections of the society, the public sector will continue to play a dominant role in the area and will have the ultimate responsibility of meeting the demands. However if private initiative comes forward to participate in creating such infrastructure like power plants, roads, bridges, social housing, and industrial estates on reasonable terms and with full protection of peoples interest such initiatives must be positively encouraged. Eighth Five Year Plan Vol. I, para The Plan did break from past tradition by recognizing a possible role for tire private sector in building infrastructure the Seventh Plan for example had made no mention at all of private investment in infrastructure but the scale envisaged for private-sector activity was limited. This conventional approach reflects the institutional arrangements then prevailing, with infrastructure services being supplied almost exclusively by tire public sector. Electric power generation included some independent private utilities supplying power to Ahmedabad, Mumbai and Calcutta, but over 95 per cent of generation and distribution of electricity for sale (i.e. excluding captive power generation by some large industrial units) was in the Central or State public sector. Roads, ports, railways and telecommunications were exclusive public sector areas. The cautious approach of the Eighth Plan contrasts with the rethinking taking place elsewhere in the world questioning the traditional acceptance of the public sector as the natural supplier of infrastructure services and shifting towards a positive preference for private sector suppliers wherever possible. This shift has been triggered by several factors. One is the general disillusionment with public sector performance, which has 2/18

3 created a perception that public sector operations are inherently inefficient and comparatively insensitive to consumer concerns. On this view, the public sector is a natural supplier of infrastructure services only where the service involved is of a basic nature, with relatively Sow expectations of quality and a low ability to pay. As expectations of quality increase, with corresponding willingness to pay for better services, it is appropriate to shift to private sector suppliers. Privatization has also been driven by technological developments in some sectors which make it possible to introduce private sector suppliers where it was infeasible earlier. The development of cellular and wireless telephone, for example, makes it possible to have more than one competing supplier for local telephone services whereas earlier, economies of scale prevented introduction of a competitor operating an overlapping wire-telephone network. Even if full competition in all parts of the system is not feasible, it is possible to 'unbundle' the system and introduce competition in some segments. In the power, sector for example, electricity distribution may have to be organized on the basis of a single supplier for each area, because of the expense of creating an overlapping distribution network, but there can be competition in the generation of electricity with independent power producers selling electricity to the distribution system on the basis of suitable long-term contracts combined with spot sales. 2 Another major factor triggering the shift to privatization is the tremendous growth in capital markets and innovative means of finance which makes it possible to finance large infrastructure projects despite the long payback periods involved. 2 Advances in electronic metering in billing make it possible in the U.K. for electricity distributing companies to optimize purchase of electricity from competing suppliers quoting rates for electricity, depending upon availability in different parts of the system, which vary within the same day. The economic rationale for private investment in infrastructure has to be grounded in the expectation that private sector suppliers, operating within a competitive framework, will reduce costs to the economy and thus promote efficiency. It is important to distinguish here between costs to the economy and costs to the consumer. Public sector supply of infrastructure services may appear cheaper for the consumer if the service is provided at highly subsidized rates or, as in the case of roads, even free of charge. However, low user charges in these cases are less a reflection of economic efficiency than of hidden subsidies, usually in the form of tolerance of large losses. Consumers pay for these subsidies either directly in the form of higher taxes or indirectly in the form of other government expenditure foregone, but these costs are not always recognized. In any case continuation of low-cost, public sector supplies is not an option because our ability to bear the hidden subsidies involved is now severely limited. Increasingly therefore infrastructure services, especially of the higher quality variety, will have to be provided on the basis of full cost coverage, whether through the public sector or the private sector. Consumers consequently have a direct interest in ensuring economic efficiency and if private sector operations are more efficient, it is logical to devise infrastructure strategies which encourage private investment in infrastructure. There was little discussion of these issues in the Eighth Plan document, and certainly not enough recognition of the positive need to introduce private-sector suppliers in order to achieve greater efficiency or improve the quality of service. Telecommunications is perhaps the only sector where the Plan came close to recognizing this aspect of privatization. Without a bold initiative for allowing private enterprise in areas hitherto kept as a preserve of the public sector it is apprehended that the long term objective of improving telecom services in the country 3/18

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