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India Business Frontier

India Frontier Advisory


September 2008 Research & Strategy in and beyond emerging markets

Infrastructure Development: India’s Achilles heel?


Zanele Hlatshwayo, Business Analyst at Frontier Advisory

Contents: The Indian Infrastructure Investment significantly on India’s economic and


Poor Infrastructure: India’s Achilles heel? Conference takes place from the 6th social growth. According to official
..................................................................1-4 to the 8th of October 2008 in Mumbai. statistics from the Indian Finance
India Inc in Africa........................................5 The Indian government has committed Ministry, the country’s GDP growth could
to spend around US$ 500 billion in be several percentage points higher.
A look at India’s Infrastructure
Sector.....................................................6-10 the next five years on infrastructure
development domestically. In this The Indian economy is currently
Frontier Advisory Profile..........................11
Infrastructure Special we take a expanding rapidly, with a growth rate
look at Indian Infrastructure and the of 8.5% in 2007. This has in turn
opportunities for companies wanting boosted growth in domestic disposable
to enter this sector. income, allowing consumers to demand
good infrastructure services such as
Assertions that India is ‘open for an efficient public transport system,
business’ have come as a contrast to adequate power and water supply and a
wide-spread investor frustrations at good road network.
the slow pace of improvements to its
infrastructure. Analysts have warned that India’s
steady economic growth may widen its
Years of underinvestment in infrastructure gap particularly in light
infrastructure networks has impacted of the country’s significant increase in

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September 2008 Research & Strategy in and beyond emerging markets

urbanisation. The IMF estimates that India’s three largest cities are all expected to
grow at 20% per annum until 2015.

India’s Real GDP growth, percentage (2000-2008)

12,000

10,000

8,000

6,000

4,000

2,000

0
2000 2001 2002 2003 2004 2005 2006 2007 2008 (f)

Source: International Monetary Fund

In response to India’s rapid economic growth, the government is increasingly


engaging the private sector in the provision of infrastructure construction and
services.The country’s immaturity in private-sector involvement can in part be
attributed to its historical issues with concession commitments and poor governance
practices. As a consequence, this limited the degree of interest from international
investors.

However, the government has now made significant reforms in the regulatory
framework for infrastructure, by lifting caps on foreign investment and reforms
in the approval processes. As a result of these and other government initiatives,
investments in infrastructure have increased and the sector is now attracting attention
from the international investor community.

As such, Indian infrastructure funds are being established at a rapid pace. In 2007
these funds were responsible for approximately 80 deals, totalling around US$ 1.6
billion across key infrastructure sectors.

To date, foreign players are primarily investing in the transport (airports and ports) and
telecoms sectors.For example,in 2006 the Indian government awarded South African
airports company ACSA (in partnership with Bidvest International Group and GVK)
a 30-year contract for the modernisation and maintenance of Mumbai International
Airport.

Given India’s complex bureaucratic structure, local partnerships are important and
international investors are generally either buying stakes in local companies that own
infrastructure or setting up partnerships with local developers and investors.

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September 2008 Research & Strategy in and beyond emerging markets

Bottlenecks in Infrastructure Development


The bottlenecks in transport and energy infrastructure and the sluggish pace of
investment in these sectors over the past few decades has impacted the transport-
intensive industrial sectors and impeded the development of an industrial base.
India has a desperate need for the latter as a strong industrial base will help curb its
unemployment rate.Similarly the building of infrastructure has the potential to create
positive employment effects in the construction industry.

India’s principal advantage as a developing economy – a large, low-cost labour


force – is being undermined by a combination of inflexible labour laws and low-
quality physical and social infrastructure. Indian manufacturing, despite pockets of
excellence, is on the whole struggling to become competitive.

Annual Inbound FDI Flows China vs India (USD bn)

80

70

60

50
USD bn

40 India
China
30

20

10

0
2002 2003 2004 2005 2006 2007

Source: Deutsche Bank 2008

The country’s export trade currently amounts to 1.5% of global trade, and is expected
to grow to 1.9% in 2011. This contrasts with China’s 7.7% of global trade, which is
projected to grow to 10.8% by 2011.

To meet the economic growth target of 9% laid down by the government in its 11th
five-year plan (FYP) effective from 2007, significant investments will be needed to
ease these and many other infrastructure bottlenecks. The government has estimated
the required expenditure at around US$ 320 billion by 2012 and hopes that about
40% of this will come from the private sector.

Nevertheless economists argue that the shallow long-term corporate debt market, the
perceived lack of bankable infrastructure projects and ideological/political opposition
to privatisation will leave the government shouldering far more than 60% of the
financial burden.

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September 2008 Research & Strategy in and beyond emerging markets

Planned investment in infrastructure in India until 2012 (11th FYP)

300
250
200

USD bn
150
100
50
0

Railway infrastructure

Telecommunications
Energy sector

Road infrastructure

Seaports

Airports
Water
Source: Government of India, Department of Commerce 2008

A further constraint to a more rapid development of India’s infrastructure is the fact


that in terms of infrastructure planning, the balance of power is gradually changing
from the dominance of the central government to the 28 states and seven territories.

The impact of this is that there has been a trend in decentralisation that has resulted
in complex regional bureaucratic systems which has slowed down the process of
infrastructure development. Until recently, the national government did arguably little
to pressure the federal state authorities to promote infrastructure projects in their
respective states.

Conclusion
Poor infrastructure is clearly India’s Achilles heel. But it is also the area that is
receiving the most attention from policymakers and one that offers significant
opportunities to private investors, both domestic and foreign.

Improving India’s infrastructure will drive economic growth, will provide opportunities
to reduce the country’s unemployment rate, boost domestic consumption, lower
operating costs within the country and stimulate exports.

On the other hand if India’s infrastructure development continues to lag behind its
competitors particularly China, foreign investment could stall and development will be
focused solely on services industries such as IT outsourcing.

Failure to make more rapid progress in developing India’s infrastructure, whether


ports, rural roads, power plants or mass transit systems, will cost the Congress-led
coalition any realistic chance of securing not just its objective of double-digit growth
by the end of the five-year plan, but also several other development goals.

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September 2008 Research & Strategy in and beyond emerging markets

India Inc in Africa


Frontier Advisory tracks India’s commercial movements in Africa. This section provides an overview of key investments in the
last two months.

Egypt
Tata and Essar vie for steel deal
The Egyptian government is considering Tata
Steel, India’s largest steel producer, and Essar
Steel Holdings for a US$ 3 bn steel and billet
plant which would focus on exporting to the
subcontinent. The two Indian companies are Ethiopia
among seven global firms who have made it to Indian group to invest in
the final round of bidding.
sugar and paper
The Chadha Group, an Indian
conglomerate, will invest a total
of US$ 190 mn into the creation
of a sugarcane plantation in
addition to facilities for the
production of sugar, paper
and ethanol. The company is
planning to start the plantation
of sugarcane on 100,000
hectares of land in West Shoa
of Oromia Regional State.
Kenya
Indian company to invest US$
500 mn
Essar Global Ltd is set to invest
US$ 500 mn in Kenya’s newest
mobile phone service operator,
Econet Wireless Kenya Ltd,
over the next two years. Recent
comparative statistics on the
East African Community show
that Kenya has the highest
number of mobile phone users
in the region. This is Essar’s
first move into sub-Saharan
Africa and could pave the way
for future investments into
Kenya and the rest of Africa.

Mozambique
BPCL invests US$ 75 mn in Mozambique
Bharat PetroResources (BPRL) has spent US$
75 mn in order to purchase a 10% stake in a
Mozambican oil block. BPRL has gone on to
state that “the closing of the transaction under the
agreement is subject to regulatory approvals of the
Mozambique government”.
South Africa
Carborundum buys 51% in South Africa’s Foskor Indian Railways to transport coal in
Zirconia Mozambique
Indian abrasives maker Carborundum Universal Ltd has RICON, which is a joint venture between IRCON
acquired a 51% stake in South Africa’s Foskor Zirconia and RITES two of India’s leading Public Sector
Proprietary Ltd for an undisclosed sum. Foskor Zirconia is Undertakings (PSU), has been given a 25 year
the third-largest producer of Zirconia in the world. concession to rehabilitate, operate and upgrade an
850km long rail line in Central Mozambique which
will also include the Beira Port. The upgrading of
the rail line is required to ensure the transportation
of coal. The improvement will cost around US$ 260
mn whilst the rehabilitation and operation of the
line will cost US$ 180 mn.

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September 2008 Research & Strategy in and beyond emerging markets

A look at India’s Infrastructure Sectors


Zanele Hlatshwayo, Business Analyst at Frontier Advisory

As mentioned in the previous article, increase in road traffic is expected to rise up


the inadequacy of India’s transport to 2015 by 15% per year on average.
infrastructure, in both quality and quantity
terms, is one of the biggest curbs on For this reason, the Indian government
economic growth in the country. The has launched the National Highway
economic losses from congestion and poor Development Programme (NHDP) which
roads alone are estimated to be as high as provides for a total investment volume of
US$ 6 billion a year. around Rs 2.3 trillion (US$ 55 billion) up to
2015.
India has made considerable progress
in the past 10 years in attracting private The most important project is the upgrade
investment into infrastructure: first in of the Golden Quadrilateral which will
telecommunications, then in ports and significantly improve the highway linking
roads, and most recently in airports and India’s four main business centres: Delhi,
container freight. Mumbai, Chennai and Kolkata.

But progress elsewhere is considerably The government is relying on the support


slow. Moreover the private sector is unlikely of private investors both locally and
ever to be a realistic source of funds for the internationally for financing the NHDP and
investment needed in vital areas such as other road construction projects.
rural roads and irrigation.
Nevertheless the national road-building
Roads programme has slowed down in the past
National highways in India currently carry two years, falling to just over 800km 2007
about 40% of the country’s total traffic and from 2,500km in 2005, despite soaring sales
Gridlock cripples cities such as Bangalore, of trucks and cars.
Mumbai and Gurgaon. Going forward, the

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September 2008 Research & Strategy in and beyond emerging markets

India Road Networks 2006

Length (km) Share %

65,950 2

128,000 4

470,000 14

2,650 80

Source: Department of Road Transport & Highways, India

Railways
In terms of length of railway network, India has one of the most extensive railway
networks in the world with about 63,000km of track. This roughly matches China’s
railway network. However, investment and maintenance of India’s rail infrastructure
has been insufficient in recent decades.

Moreover the capacity bottlenecks on heavy travelled railway routes combined with
the system-related advantages of other transport modes means that private investors
play a small role in financing the necessary railway infrastructure than is the case with
other modes of transport.

Nevertheless the Indian government has allocated around Rs 2.3 trillion (US$ 55
billion) to railway development projects. A new dedicated 1,469km freight line is under
construction from Jawaharlal Nehru Port, near Mumbai, to Dari, near Delhi. Work on
the 1,469km line will cost Rs114 billion (US$ 2.77 billion).

The question remains whether the new corridors will be built fast enough to handle
the surge in traffic growth and rail liberalisation will be effective enough, given that
state-owned Concur, which is jointly owned by Indian Railways and the central
government, will still haul the trains.

Increase in Indian railway traffic (2001-2011)

0

2001 2003 2005 2007 2009 (f) 2011 (f)
Passengers (bn) Freight (m tonnes)

Source: Indian Ministery of Railways

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Seaports
India has twelve major ports and around 190 small ports along its 7,500km coastline.
Overall the ports handle 95% of India’s trade in goods by volume and 70% by value.

The Indian government acknowledges that in order to reach its target of more rapid
industrialisation, as well as achieving global status as a top player in world trade, the
country must expand its port capacities. As a consequence of this, the government is
aggressively pursuing its plans to expand and modernise ports across the country.

The projects are mostly being implemented through private-public partnerships


(PPPs) and as such, there has been a significant increase in private investment in
port terminals. Nevertheless, government interference has been cited as a major
concern for international private investors looking to invest in Indian ports.

Composition of main Indian port traffic (2006 - 2007)

Source: Indian Ports Association

Airports
Air traffic in India is set to boom over the next five years. Passenger traffic is expected
to increase by 15% per year and cargo traffic by 11% per year on average until 2015.

The Centre for Asia-Pacific Aviation, a consultancy, predicts that domestic traffic will
grow 25-30% per year until 2010, with international traffic growth at 15%, taking the
overall market to more than 100 million passengers per annum.

The trend towards deregulation of the Indian air transport market is likely to continue
thus dismantling the remaining market entry barriers for private airlines in cross-
border traffic. The Indian government is responding to the expectations of higher air
traffic by investing in the modernisation of existing airports as well as the construction
of new ones. In 2008, the government announced that 35 new airports will be in
operation by 2009.

Similar to seaports, the majority of airport infrastructure projects in India are financed
through PPPs. The public funds needed for these projects are estimated at Rs 400
billion (US$ 9.5 billion) up to 2010.

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September 2008 Research & Strategy in and beyond emerging markets

Expansion of Indian air traffic (2002-2012)

300

250

200

Total passengers (m)


150
Domestic passengers (m)
100

50

0
2002 2004 2006 2008 (f) 2010 (f) 2012 (f)

Source: Airports Authority of India

Telecoms
As the telecoms sector shows, where private capital and management disciplines
have been introduced the results have been remarkable. Indian telecommunications
has become one of the fastest-growing telecommunications markets in the world.

The industry added more than 5 million subscribers a month on average during
2007 and is expected to have 575 million within five years. It has moved from being
a country with one of the most expensive tariff rates in the world to one with the
cheapest.

Energy
As industry expands and rising incomes create greater power demand from
consumers, energy consumption will steadily grow.

With about 70% of India’s population is based in rural areas – much of which is
without electricity – per capita energy consumption was just 594 kilowatts in 2003,
according to the UN Development Programme, against 14,057 kW in the US.

The main reason for the supply bottlenecks is the previous shortage of investment in
power stations and the grid which failed to keep pace with the increase in demand.

In response to the power-supply problems, the Indian government has launched a


series of development programmes which include modernising power stations and
building new facilities.

The 11th FYP calls for an investment volume of Rs 10.3 trillion (US$ 245 billion). With
regards to opportunities for foreign investment, the investment climate in the Indian
energy sector is still largely prohibitive and until regulatory barriers are dismantled, the
scope for foreign investment in energy infrastructure is highly limited.

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September 2008 Research & Strategy in and beyond emerging markets

Moreover power remains a highly political issue in India because much electricity to
rural areas and farmers is supposed to be free.

That leaves fewer options for some state-owned power companies to operate like
incentive-driven private companies. Until that happens, the leading players in many
industries will continue to sidestep the problem by building their own private power
stations.

Share in installed electricity generation capacity 2007 (%)

13.80%

52.40%

34.00%

States Central government Private sector

Source: Indian Ministry of Power, 2008

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September 2008

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