Macro Study: Categorising The Infrastructure Sector In Terms Of Commercial Value Proposition
Infrastructure assets are commonly thought to be goods that are to be made available to all citizens, irrespective of their ability to pay. In theory, such goods are characterised by three features. One, they are public goods, or goods that are both non-excludable (individuals cannot be excluded from accessing it) and non-rival (use by one person does not reduce the availability to others). But in the real world, there are hardly any pure public goods. Further, the same activity or sector may have very different risk-return profiles in developed and developing countries.
Infrastructure assets, even public roads, are not purely non-rival and could be made excludable. But, depending on the circumstances, infrastructure assets can have one or both of these features.
Infrastructure assets, in general, generate positive externalities – public benefits (costs) exceed private benefits (costs). This is an argument in favour of public provisioning of these assets. Even if privately produced, there is a case for some form of public subsidy so as to ensure everyone can access the service.
Finally, they exhibit monopoly characteristics. This makes their pure private provisioning fraught with problems and necessitates either wholesale public provisioning or private provisioning under regulated conditions.
Further, the nature of infrastructure assets changes over time. Take the example of electricity, for long delivered by monopoly public entities. However, once the sector got unbundled into generation, transmission, and distribution, the nature of each of the unbundled sub-sectors changed dramatically. Generation no longer exhibited monopoly features and could easily be delivered by the private sector.
In contrast, the transmission and distribution lines still remained monopolistic and had to be publicly owned or be regulated if privately owned. However, they were designated as common carriers, with an obligation to carry power for anyone willing to pay the carrier fees (or wheeling charges). It then became possible to have multiple private providers use the same transmission and distribution lines and sell their power to consumers. This feature is common with all the utility services – water, sewerage, communications, electricity, gas, and transportation. In all these cases, the wires or the tracks have monopolistic features but have been designated as a common carrier to allow use by multiple private providers.
As can be seen, the design of appropriate regulation assumes significance in facilitating private participation in a hitherto monopolistic sector. The other important distinction of relevance in infrastructure is that between greenfield and brownfield projects. The former refers to new construction or development of an asset, whereas the latter refers to existing assets which are already serving consumers. As we shall discuss in detail later in the series, their respective risk-profiles are very different. This, in turn, determines their respective attractiveness to the private sector.
Finally, there is the possibility of private production and public provisioning of certain infrastructure assets and services. For example, a publicly financed insurance program which allows for treatment in private hospitals involves public subsidy to private hospitals. Similarly, a voucher system allows for public provisioning of private schooling. Taking all the aforementioned dimensions together, in terms of their commercial value
a proposition, there are perhaps four different categories of infrastructure assets.
1. Category I – Certain types of infrastructure assets can recover their construction and operation costs through tariffs or user-fees, and they are therefore commercially viable. They include sectors like telecommunications, power generation and transmission, gas transmission and distribution, high traffic roads and railway corridors, and bulk water supply. Some of the largest airports and port terminals too come under this category.
The first three are essentially private goods purchased at market prices from regulated entities given their monopoly features. In case of certain roads with high traffic as well as with annuity projects, the risks borne by the investors are minimal. It is, therefore, no surprises that power generation, roads, and telecoms form over 90% of the $265.8 bn worth PPP projects in India over the 1990-2018 period. Add in airports and ports, and the rest all put together is rounding error4
2. Category II – Certain other types of infrastructure assets can be made commercially viable if a part of the development cost is excluded or covered otherwise. They include sectors like many road stretches and metro-rail projects on high density routes, or airports and ports. Or those in general which require large capital expenditures, but which also have stable long-term revenues though they are unlikely to off-set the large investment required. They can be made commercially viable if a part of the capital expenditure is subsidised.
Such support, in turn, can be in the form of concessions and subsidies directly transferred to the project asset or in the form of viability gap funding in the bidding process. Examples of the former include the transfer of land parcels to a metro-railway project so as to generate additional real-estate based revenue streams that make the total project commercially viable. Examples of the latter include the transfer of viability gap to airlines as part of the UDAAN program to service remote regions.
3. Category III – These are sectors which can theoretically be commercially viable, and some of them are so in some developed countries. However, especially, but not only, in developing countries, but they also suffer from both construction and operational uncertainties. Water and sewerage, and solid waste management, and power
distribution are good examples of such assets.
Developers would, therefore, be reluctant to bid for such projects. Investors would be hesitant to invest in such projects without significant risk mitigation. The risks associated with these projects emerge from the politically sensitive nature of the service they deliver, which creates uncertainties about its revenue stream or the rate of its growth assumptions. Utilities, in particular, are associated with regulated tariffs, whose contracted increases often get embroiled in the local political economy and come to nought. Or in some cases, where the private contracting of such services is very new, or where the technology or business model innovations are new, the private sector is likely to be hesitant in committing capital.
4. Category IV – All the remaining infrastructure assets, which generate limited cost-recovery, are best financed by governments. Most social infrastructure works like schools, hospitals, irrigation etc., belong to this category. In the case of such projects, private participation, if at all, can be leveraged through service concessions for
specific activities like facilities or assets management.
Thus, it must also be noted that the risk-return profiles vary not just widely across the different sectors, but even within sectors. For example, electricity generation and distribution, or water treatment and distribution, have very different risks and returns. It varies significantly based on the stage of the project, mainly construction and operation. It varies across geographies and locations.
Some are fully commercially viable, some not at all. Some can be made commercially viable using public finance or enabling. policies, many cannot be done so. Some face risks, some uncertainties, and some both. Complicating matters, with the evolution of the market, these profiles vary. The illusory comfort with viewing infrastructure as one asset category can, therefore, be very misleading.
Gulzar Natarajan is an IAS Officer. Views expressed are personal.
This is the first article in a multi-part article series on infrastructure financing and the challenges associated with the sector.