Infrastructure reform key to attracting new investment in India


21 May 2014

Infrastructure reform key to attracting new invest...

Indian shares and the value of the rupee rose as election results were announced last week, showing market optimism about the planned economic reforms of the BJP government. The Indian economy needs revival after years of slowing growth and rising fiscal deficit. Foreign investment will be essential to driving growth, but this will be heavily dependent on the country’s ability to overcome political and bureaucratic barriers to address fundamental infrastructure deficiencies. Although in isolation reform to India’s infrastructure will not alleviate the country’s vast economic challenges, it is vital to securing increased foreign investment and establishing foundations for long-term growth.

Modi is under pressure to act quickly in clarifying how the government plans to address the high fiscal deficit, currently estimated to be 4.6 percent of GDP. Credit ratings agency Standard & Poor’s have warned it could lower India’s rating to junk status if it does not address some of the country’s pressing economic issues. The detail behind campaign pledges to ensure fiscal discipline now need to prove their substance. Core issues such as labour reform, job creation, reducing vast subsidies that constitute 2.2 percent of GDP annually, and tackling high inflation are all key economic challenges the new government faces.

 

Attracting foreign direct investment (FDI) will be vital, following declines in 2013 compared to the previous year. India ranked 134 out of 185 countries in the 2014 World Bank Ease of Doing Business report and has shown few signs of progress in the past four years, being overtaken by several other emerging markets. Foreign operators face a multitude of challenges investing in India, including high levels of bureaucracy, restrictions on land ownership and rigid labour laws. Yet it is India’s infrastructure deficiencies that are perhaps its biggest single impediment to long-term growth.

The World Economic Forum Global Competitiveness Report cites infrastructure weaknesses as the most commonly cited challenge for foreign operators in India. Ports and roads are clogged and rail infrastructure needs investment to alleviate high levels of cargo transported on the country’s highways. A report commissioned by the Transport Corporation of India (TCI) claimed that slow movement on Indian’s highways, compounded by extremely slow road tolls, costs the economy more than USD 680mn a year. Average speeds for trucks on the Delhi-Mumbai highway are 17km/h, according to the report. Airports run at high capacity and have generally failed to keep pace with rising demand. Supply chains are severely affected by India’s inadequate level of infrastructure and this threatens to dent India’s ambitions to become a new global hub of manufacturing amid rising labour costs in China. Beyond transport, power is a major infrastructure constraint in India, regularly highlighted as an impediment to business. Unpredictable supply can impact productivity and reforms are needed to upgrade old infrastructure and diversify away from state-run coal-centric power systems. The mass blackout across northern India in 2012 that affected some 370 million people is illustrative of the need for reform and invest in electricity grids.

 

The government introduced deregulation to tariffs in the port sector in 2013, prompting a significant rise in investment in ports. Continued development in this area will be necessary to support increased Indian cargo handling and improve the efficiency of cargo turnaround at Indian ports. However, deregulation alone will not facilitate infrastructure growth and tackling bureaucratic hurdles, corruption and addressing the significant fiscal autonomy of India’s states will be critical to securing effective infrastructure development.

Addressing the fiscal independence of Indian states will be major hurdle for Prime Minister Modi. The planned introduction of a goods and services tax will be crucial to strengthening the economy and could help address the frequently cited complaint over inconsistent tax structures between states, which add complex administrative and financial procedures for companies operating or moving goods across state borders. It is also crucial in addressing India’s infrastructure requirements and speeding up investment projects. A Credit Suisse report highlighted that three quarters of infrastructure projects sit with state governments rather than authorities in New Delhi.

Reforming decision-making in infrastructure project should also incorporate a review of land ownership. Disputes over land add 15-20 percent to estimated project times for 90 percent of road projects in India, according to the consultancy McKinsey. Evidently, the issue of land disputes sits not only in politics and an overhaul of severe inefficiencies in the legal system are needed to rectify this.

The early economic optimism should be tempered with appreciation for the challenges ahead. Modi will face political opposition in seeking to restructure the fiscal autonomy of Indian states, addressing high subsidies, labour reform and tackling vested interests in state owned companies, among other measures. His boldness in taking politically unpopular decisions may help shape the effectiveness of economic reforms in the next four years. Addressing India’s infrastructure shortfalls will take time to manifest and will not remedy the multiple economic challenges the country faces in the short to medium term. They are however, fundamental in helping India secure longer-term growth and securing FDI.

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