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Past Issue • Jul-Sep 2014

Increasing Value for Money in Infrastructure Investment

The newly elected Government of India’s key objectives include initiating reforms in the critically important infrastructure sector. While raising investor confidence is essential to strengthen the sector and India’s economy, Oshani Perera and Tilmann Liebert elucidate on how adopting investment practices that adhere to the principle of ‘value for money across the entire life cycle of an asset’ can ensure sustainable and equitable development.

The Case for Value for Money
We write this article as the newly elected Government of India takes oath and pledges to work towards development and economic reforms for a “glorious future for India” as Narendra Modi pronounced when sworn in on May 26, 2014. Among the top ten priorities of the incoming administration are infrastructure reforms with the objective of raising investor confidence. This is to be welcomed, as infrastructure is paramount to Indian prosperity. With a planned doubling of investment in infrastructure to Rs 40.9 trillion during the 12th Plan period (2012–2017) (E&Y & FICCI, 2012), it becomes extremely important for the new government to ensure that whatever is ultimately invested will yield value-for money for the public purse.

And there is where the crux of the challenge lies – value for money needs to be achieved not simply at the point of purchase, or the point of commissioning, but across the entire life cycle of an asset. Interpreting value-for-money as the ‘lowest purchasing price’ means that the Indian tax payer is being shortchanged. It gives rise to public assets and services that are poorly designed, incur massive cost overruns during construction, are very expensive to maintain, deliver poor services to users and thus bring even lower returns to its investors. Evaluating value-for -money across an asset’s life cycle can avert such losses and, moreover, increase certainty and stability to the Indian investment climate.

Why Value for Money is not being Optimised

As discussed in the International Institute for Sustainable Development (IISD) report Value for Money in Infrastructure Procurement: The costs and benefits of environmental and social safeguards in India (2014), the legal and institutional provisions to enable the Government of India to act on achieving value for money across the asset life cycle are already in place. Laws and regulations on the establishment and structuring of public-private partnerships (PPP) are amongst the best in the emerging economies. Provisions on environmental and social safeguards are best in class. The Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act of 2013 provides much needed clarity on compensation and entitlements and the protection of livelihoods. The modernised public procurement bill, that is expected to be passed in 2015, includes environmental performance on par with price, quality and suitability as the foundations on which public tenders are to be awarded. These ambitious provisions now need to be put into practice; however, both existing and upcoming policies in this space face strong headwinds. As Pradeep Singh, Deputy Dean of the Indian School of Business (ISB), says in the Foreward of the above IISD report, “Infrastructure development cannot, and must not, take place at the expense of the environment and livelihoods. But the irony is that the vast resources, time and energy targeted at social and environmental improvements are, in the end squandered. Large amounts of time and money are currently deployed by both investors and government (and its agencies) to conduct the required assessments and to comply with the mandatory environmental and social safeguards without translating into meaningful improvements on the ground. The emphasis continues to be on the paper chase of pre-project approvals rather than on the subsequent implementation and enforcement”.

The legal and institutional provisions to enable the Government of India to act on achieving value for money across the asset life cycle are already in place. Laws and regulations on the establishment and structuring of public-private partnerships (PPP) are amongst the best in the emerging economies. Provisions on environmental and social safeguards are best in class.

The first challenge that prevents policies from having their intended effects in the real world is one of capacity. Regulators are under-funded and have poor scientific and technical expertise to monitor compliance. Nor do they have the political clout to enforce environmental and social performance that will improve the whole-life-value of projects.

The second problem lies in the fact that the benefits of environmental protection and social cohesion are difficult to monetise. Hence associated risks pass unnoticed in project financing analyses. Yet it is precisely these that pose massive challenges to infrastructure development. Public protests on land tenure issues cause long delays in construction and deter both foreign and domestic investors. When recommendations of environmental and social impact assessments are not built into the final engineering plans and technical specifications, they increase construction costs and directly lead to additional uncertainties linked to community relations, environmental damage and technical design. When energy, carbon and material intensities are not factored in at the design stage of the asset, the project becomes more costly to operate and maintain. And if the right stakeholders are not consulted during project planning, multiplier social gains in terms of skills upgrading, employment and secure livelihoods are lost.

The third central problem that prevents realising value for money lies in political will. The Government of India to date has not established and enforced sufficiently punitive penalties on those that violate environmental and social safeguards that demine whole-life-value. Instead of acting as the proverbial stick that leads firms to rectify behavior, the fine is too often so ridiculously low that it is cheaper to simply pay it – even again and again – than to comply. On the other side, this also means that the CEOs and investors that are committed to sustainable development are not sufficiently rewarded for their leadership. Penalties have to be set at the right level – and be enforced – if they are to have their intended effects encouraging whole-life-value.

Using Public Procurement as a Vehicle for Whole-Life-Value

Solutions for improving whole-life-value in the Indian infrastructure sector may be more easily found than we now think. The various stages and components of the procurement cycle, through which infrastructure assets are commissioned, provide several ways to introduce value for money.

To begin with, Requests for Proposals (RFP) and calls for tender can already include technical specifications, award criteria and contract conditions to spell out environmental and social performance. For example, in the case of the six-laning of the 555 km Kishangarh-Udaipur-Ahmedabad Highway, the project can be assumed to have had energy requirements equivalent to 1.2 million tonnes of CO 2—equal to the annual emissions of 700,000 Indians (IISD, 2014; World Bank, 2013). If the RFP had, in this case, incorporated criteria on the use of recycled materials, reduced imported aggregate, or the replacement of traditional hot-mix bituminous asphalting with a new cold-mix process, significant energy and cost-savings would have been realized. This last technical aspect alone could have potentially reduced CO2 emissions by 55 per cent (WRAP). With Prime Minister Modi’s recent commitment to have 25 km of new highways built per day, these impacts become even more relevant (Hindustan Times, 2014).

To provide tangible incentives for the building of expertise on sustainable infrastructure, authorities can include environmental and social expertise requirements into PPP contracting pre-qualification criteria. Such a move would support raising the bar on sustainability performance.

Another example is the valuation of wetlands that are valuable due to their provision of natural protection against floods, purification of water and production of nutrients for fisheries. Due to these and other benefits, such ecosystems are estimated to have a value of around US$ 14,785 per hectare per year due to the services they provide (Ramachandra et al., 2011). If an infrastructure project was to lead to the destruction of 306 hectares of pristine coastal wetlands – as was planned for a project in Andhra Pradesh – the total lost value of ecosystem services would have been approximately US$4.5 million per year. This illustrates the significant value of services provided by the land to the local and global population – a value that was not identified in the beginning of the PPP decision-making and appraisal process. Factoring in such considerations into the tender documentation that is the base for every project, could lead to a broader consideration of alternative sites, technologies, and to increasing value for money across the lifecycle of an asset.

To provide tangible incentives for the building of expertise on sustainable infrastructure, authorities can include environmental and social expertise requirements into PPP contracting pre-qualification criteria. Such a move would support raising the bar on sustainability performance and increase the expertise of bidders on environmental technologies and engineering, green buildings, environmental management systems and more. To ensure that no suppliers are crowded out, environmental and social performance criteria should be introduced in an incremental manner, beginning with the adoption of baselines standards such as ISO 14001 on Environmental Management.

Investors and promoters of infrastructure in India are wary of disputes, delays and other construction risks associated with environmental and social clearances. To counteract these challenges and improve the investment climate, the Government of India could absorb all legal risks by obtaining all clearances before the request for proposals is launched. IISD estimates that in India, time and cost overruns can increase average infrastructure project costs by 16.5 percent. Indeed this recommendation is in line with the Department of Economic Affairs’ Draft National Public Private Partnership Policy, under which the public sector should obtain land and clearances, thereby taking over the associated risks from the private sector. This approach is already being followed for ultra-mega power project PPPs which can serve as a model in some regards.

Once construction of an asset has begun, or once it is already in operation, the technical and scientific capacities of regulators to monitor it are limited. The poor capacity of regulators to hold those incompliant to account, is perhaps the weakest link in the infrastructure value chain. This is a problem not just in India but all around the world. Enforcement is expensive and in many instances, developers find it cheaper to pay the fines and continue business-as-usual than improve their environmental and social performance. Non-compliance is also not punitive socially: if violators were named and shamed and barred from contracting with the public sector for a certain period of time, environmental and social performance that ultimately renders whole-life-value would be held in much higher regard by investors, developers and policy makers alike.

An avenue for enabling sustainable infrastructure financing is for the Government of India to further step in and share investment risks by tweaking the existing infrastructure financing facilities. For example, the Viability Gap Fund (VGF) that provides a one-time capital grant to infrastructure PPPs that are economically justified but not fully financially viable

Tweaking Financing Facilities to Favour Sustainable Infrastructure 

Providing financing instruments and incentives for environmentally and socially sustainable projects is perhaps the most critical piece of the whole-life-value puzzle. In most cases, building sustainable infrastructure may involve higher capital costs, which are later more than offset during the operations and maintenance phases of the project. Further financial savings from energy efficiency features, for example, can be monetised and integrated into the analysis of future cash flow and help improve the bankability of projects. But convincing investors to take the perceived risk of increased capital outlay with savings in the distant future is always challenging.

An avenue for enabling sustainable infrastructure financing is for the Government of India to further step in and share investment risks by tweaking the existing infrastructure financing facilities. For example, let us consider the Viability Gap Fund (VGF) that provides a one-time capital grant to infrastructure PPPs that are economically justified but not fully financially viable (the lack of financial viability can be due to a multitude of systemic risks, including demand, supply, legal and environmental risks that reduce the net present value of a project). The VGF is awarded at the construction stage and is equivalent to the lowest bid for capital subsidy, but subject to a maximum of 20 per cent of the total project cost. Sponsoring ministries, state governments and statutory entities are also able to provide additional funding up to a further 20 per cent of the total project cost. An effective way to facilitate green infrastructure projects will be to peg this additional 20 per cent of the VGF grant to the extent to which environmental and social sustainability is incorporated into the siting, design and construction of the project. Sustainability performance therefore becomes a requirement to access additional capital.

Further avenues to fund sustainable infrastructure can take the form of Infrastructure Debt Funds (IDFs) which, in India, are structured in two forms: The mutual fund-type IDFs allow investors to pool and diversify their investments across a range of infrastructure assets; while Non-Bank Finance Companies (NBFCs) target projects that have completed one year of commercial operations. NBFCs can also implement credit-enhancement mechanisms for infrastructure companies to achieve a credit rating acceptable to institutional investors. Further, NBFCs can issue bonds in both Indian Rupees and foreign currencies. For example, the India Infrastructure Finance Corporation (IIFCL), in partnership with the Asian Development Bank (ADB), offers credit enhancement to infrastructure companies to help them bolster their credit ratings and access the bond market for long-term funding.

Within this framework, infrastructure companies can explore the possibility of setting up specialized green infrastructure debt funds that will target investment in green infrastructure. Multilateral agencies and institutions such as IIFCL could assume the tranches of the fund with higher risk, enabling the institutional investors to step in and take up those that are investment grade. Reductions in withholding tax and the income tax holiday will be critical to ensure the viability of a green infrastructure fund until technology risks are lowered and green infrastructure markets mature.

In addition, credit enhancement facilities, lenders such as IIFCL and ADB could also explore the possibility of providing higher credit enhancement for sustainable infrastructure companies that wish to issue green bonds. To promote sustainable infrastructure, green bonds can be viable in the Indian context since a liquid market in green infrastructure bonds creates lower exit costs for the construction phase capital, as well as for the longer-term project finance debt held by banks with constrained balance sheets. In the early days it will be pertinent for governmental financial institutions to play the market-maker’s role in order to ensure liquidity on the green infrastructure bond market.

Industry leaders and policy makers in India, as in many other contexts, have yet to realise that energy efficiency is far cheaper than equivalent expansion of energy generation capacity. No doubt, energy efficiency is the most cost-effective way to address India’s energy supply gap in the short and medium term.

And finally, could it be an option for the takeout finance scheme (TFS) to give preference to banks that have notable environmental and social performance records and seek to invest in sustainable infrastructure? The TFS is implemented by IIFCL to solve the asset liability-mismatch in the Indian banking industry. These mismatches arise because the payback period for infrastructure projects are too long and typically deposits in banks are for much shorter periods. Banks hence find it difficult to provide long-term loans – 15 years or so – for infrastructure projects and the purpose of the take-out financing from the infrastructure debt funds is to help banks off-load these loans from their balance sheets. In this case, IIFCL acts as a vehicle for refinancing existing debt and so creates fresh space on banks’ balance sheets enabling them to lend to additional infrastructure projects. The TFS is especially targeted at loans for infrastructure projects on which the construction phase is already complete and the operations phase is underway. For promoting sustainable infrastructure the key question here is whether a takeout financing scheme could be created especially targeted at banks that make lending to environmentally and socially preferable projects a priority?

Whole-Life-Value in Existing Infrastructure 

Additional opportunities for generating value for money are equally prevalent in upgrading existing infrastructure: Energy efficiency measures are a particular case in point. Industry leaders and policy makers in India, as in many other contexts, have yet to realise that energy efficiency is far cheaper than equivalent expansion of energy generation capacity. No doubt, energy efficiency is the most cost-effective way to address India’s energy supply gap in the short and medium term. By upgrading levels of energy efficiency across India, electricity supply could be expanded to currently non-electrified areas, productivity could be increased and environmental and health damage from new power plants avoided – all raising the value for money of energy efficiency projects. However, there are still a series of barriers working against realising the massive potential in this area.

Standards and consumer labels on energy are in place and demonstration projects on energy performance contracts are documented. But a large proportion of these initiatives are still dependent on backing with public funds. Baselines and protocols for investment grade energy audits are not available, and this is compounded by the loss-making situation of the discoms (due to the negative difference between tariffs and electricity costs). At present, commercial banks have little incentive to fund energy efficiency as they are used to asset-based financing and not yet to the cash-flow-based one that energy efficiency projects require. In addition they lack expertise in energy efficiency. Hence there is an urgent need for a financial protocol that would enable financiers to evaluate the energy efficiency business case on their own terms.

The Government of India could further support energy efficiency investments through fiscal reform. Energy Service Companies (ESCOs) – the firms that implements projects in their clients’ facilities – are liable for corporate income tax on performance-based revenues (those from the energy savings accrued to the customer), as well as for value-added tax on the energy efficiency equipment being provided to the customer. Some ESCOs have also been required to pay income tax on delivery and installation of the energy efficiency equipment, rather than after remuneration based on the actual energy savings realised. All this makes energy efficiency non-bankable in India at present. The upcoming IISD report “Creating a Market for Energy Efficiency Investment in India”, crafted with close involvement of central business and policy actors will discuss the above and other potential solutions to this challenge and provide recommendations for the Indian energy efficiency to get closer to where it could be.

Moving to the Next Level of Sophistication 

Whether through energy efficiency upgrades, green buildings or sustainable highways; India must not simply close its infrastructure deficit, but moreover, ensure that in doing so, it generate positive economic multipliers and brings whole-life-value for tax payers at large. Pradeep Singh further remarks in his Foreword to the IISD Report “Value for Money in Infrastructure Procurement”, “Further thinking and action along these lines (whole-life-value) is urgently required if infrastructure is to trigger the positive multipliers that stakeholders in India expect and deserve to see in the coming years. The prevalent mind set around infrastructure investment needs to take a longer-term perspective. The focus should be on service delivery as opposed to short-term asset balance sheets. The emphasis in the public sector needs to shift from administrative requirements – that may or may not bring value for money – to encourage innovation in the project configuration”.

Coordination and policy cohesion may continue to be challenges. For example, in the new Indian Cabinet, the mandate for sustainable transport is shared among various ministries – viz. railways, road transport and civil aviation. There is also the need to provide greater predictability on legal risks and tax regimes.

Coordination and policy cohesion may continue to be challenges. For example, in the new Indian Cabinet, the mandate for sustainable transport is shared among various ministries – viz. railways, road transport and civil aviation. There is also the need to provide greater predictability on legal risks and tax regimes. The authors suggest that long-term tax holidays are replaced by low tax regimes and complimentary tax allowances and mandatory lending provisions for sustainable infrastructure. IISD also values India’s early efforts to lead a new era of sustainable growth across the South Asian Association for Regional Cooperation (SAARC) region and upgrading its domestic infrastructure will be a critical pre-requisite in this direction. Closing the infrastructure deficit must be seized as a trigger for wider sustainable industrial development in the years ahead. With values equivalent to 10 – 12 per cent of GDP being earmarked for infrastructure spending, the moment to act is now.

FURTHER READING

IISD (2014), “Value for Money in Infrastructure Procurement: The costs and benefits of environmental and social safeguards in India”, Perera O, L Turley, T Liebert, MH Silva, P Gonsalves, A Gupta, S Manchanda and S Nelson, January 2014, Available at: http://bit.ly/1rkLN0N (Accessed on 31 May 2014)

E&Y & FICCI (Ernst & Young Pvt. Ltd. & Federal Indian Chamber of Commerce and Industry) (2012). “India Infrastructure Summit 2012: Accelerating Implementation of Infrastructure Projects”. Available at: http://www.ey.com/Publication/vwLUAssets/FICCI_Infra_report_final/$FILE/FICCI_Infra_report_final.pdf (Accessed on 31 May 2014)

Hindustan Times (2014). Highways, tax, land acquisition: A glance at Narendra Modi’s to-do list on reforms. Available at: http://www.hindustantimes.com/elections2014/the-big-story/a-to-do-list-for-india-s-new-government/article1-1220685.aspx

Ramachandra, TV, B Alananda, A Rani and M AKhan (2011). Ecological and socio-economic assessment of Varthur wetland, Bengaluru (India). Available at:http://www.ncbi.nlm.nih.gov/pubmed/22324154 (Accessed on 31 May 2014)

World Bank (2013). CO2 emissions (metric tons per capita). Available at: http://data.worldbank.org/indicator/EN.ATM.CO2E.PC (Accessed on 31 May 2014)

WRAP. A38: Ex-situ Recycling of a Trunk Road in South Devon. Available at: http://www2.wrap.org.uk/downloads/A38_exsitu_recycling_of_trunk_road_in_South_Devon.048863ef.2933.PDF (Accessed on 31 May 2014)

 

ABOUT THE AUTHORS

  • Oshani-Perera

    Oshani Perera

    Oshani Perera is Programme Leader at the Institute for International Sustainable Development (IISD) and oversees projects on the Public Procurement and Infrastructure Finance Programme.
  • Tilmann-Liebert

    Tilmann Liebert

    Tilmann Liebert is Programme Officer at the Institute for International Sustainable Development (IISD) and manages projects on sustainable procurement and infrastructure.
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