Why Timely Enforcement Of Contracts Is Critical To India’s Infrastructure Ambitions

The National Infrastructure Pipeline is the culmination of India’s ambitious project to scale up our public infrastructure. The key to the success of the project depends on a variety of factors including the role played by key stakeholders. 

One of the issues related to infrastructure development in India has been the issue of infrastructure financing. Infrastructure investments are indeed long term in nature and therefore, they block capital as the payback period tends to be high.

The asset-liability mismatch combined with increased uncertainty over time are factors that determine the risk premium on these assets. It is obvious that long-term investment in such assets that face limited uncertainty would have a lower premium than others. Therefore, pricing and cost of financing of these assets depend on a lot of exogenous factors. 

It is evident that the government of India does not have the necessary funds to be able to finance the entire pipeline of projects. That it is looking for active participation from the private sector is in itself a recognition of the limitation of the state to fulfil our infrastructure dream. However, the question is whether the private sector will be in a position to play the role as per government’s expectations or not. 

Two aspects are important here, first is the public-private partnership framework that needs to be revamped while the second has more to do with the enforcement of contracts, which has been a characteristic problem. The role played by the private sector is contingent on what we do to address both these issues. 

Recent events have exposed the inherent vulnerabilities prevalent in enforcement of contracts which remains a major challenge for further improvements in India’s ease of doing business.

The Amravati example in Andhra Pradesh would go down in history as one of the best examples of political uncertainty resulting in severe economic uncertainty as the new government decided to scrap old contracts. Another good example from Andhra Pradesh is the developments regarding existing power contracts. 

Something similar is underway in Maharashtra where we see several existing contracts being scrapped or re-negotiated. A bulk of these projects are in the infrastructure space and these developments have highlighted the impact political outcomes have on existing government contracts. Therefore, any investment project will have to price this uncertainty before the private sector comes in to finance the same. This will result in an across the board increase in the cost of financing of our infrastructure. 

A key problem here is to recognize that any unilateral action by either of the state government will have consequences for other states which will find that private players would want a higher premium to take on risks of the investment in India.

Therefore, everyone ends up losing in this case. Economics 101, reducing uncertainty results in lowering costs. Therefore, enforcement of the contract would significantly lower several costs including ‘transaction’ costs. There are political and economic reasons to think about possible ways to limit the ability of the state to renege on their contracts.

Another related issue is to address the issues related to the judiciary which is unable to handle the workload of pending cases and seems to be struggling with civil, quasi-economic cases that require a higher level of technical expertise. 

However, just improvements in our enforcement of contracts may not be sufficient as we need to revisit what we imply with Public-Private Partnerships. The focus should be on the last word and there’s a genuine need to understand the meaning of ‘partnership’ whereby the government takes the private sector as a genuine partner. Renegotiation of contracts that run into 60 years should not be met with a sense of vengeance and government should play a more proactive role in such renegotiations is required. 

A key issue over the years has been of inflated projections by the government which results in a mismatch between the private players’ expectations and the actual return from the project. In such instances, the government can look at some concessions from time to time in special projects that may not be economically feasible in the short run but are important for our welfare considerations. 

Former Deputy Chairman of Planning Commission, Montek Singh Ahluwalia has made this point repeatedly as he’s asked for a change in the PPP framework. This is important as there is adequate capital available to help the government fund its ambitious infrastructure program. It is a welcome step that the government recognizes its limitations and it is willing to allow the private sector to play an important role. However, it is equally imperative that we address some of the concerns that the private sector may have in order to act as a facilitator. 

Good economics is seldom good politics, however, occasionally, the two do meet. Improving our enforcement mechanisms and strengthening our partnership frameworks is one such occasion. Hopefully, the government would recognize the same and address some of these issues which could potentially lead to an infrastructure revolution across the country.