Skepticism abounds over whether the nearly $3 trillion Indian economy is growing fast enough to reach Prime Minister Narendra Modi’s GDP target of $5 trillion by 2024-2025. But signs suggest that economic activity may have bottomed out, and foreign institutional investors are placing big bets on India’s infrastructure sector, according to participants in a panel discussion at the recent Wharton India Economic Forum held in Mumbai.

Foreign investors are attracted to “butterflies” or cash-flow generating assets like existing airports to operate and use as a cushion to invest in greenfield projects, the panelists said. They are optimistic also because of improved transparency in governance of projects, auction systems for allocation of licensing for public resources, the existence of a top tier of well-managed private companies and other market mechanisms such as the creation of funding platforms for infrastructure, they noted.

In order to reach its GDP goal of $5 trillion, India’s economy will need to grow at a sustained rate of 9% over the next five years, according to C. Rangarajan, former governor of the Reserve Bank of India, the country’s central bank. The International Monetary Fund (IMF) on January 20 sharply revised downward India’s growth forecast by 130 basis points to 4.8% for 2019-2020. In its World Economic Outlook update, IMF chief economist Gita Gopinath said growth in India slowed sharply “owing to stress in the non-bank financial sector and weak rural income growth.”

Three Metrics That Matter

“At some level, the growth rate is an irrelevant number,” said Alok Kshirsagar, senior partner at consulting firm McKinsey, who leads its risk practice in Asia. He noted that “we obsess about” the growth rate and listed three metrics that matter. The first is the pace of private and public investment, particularly investment in terms of actual capital expenditure and capital formation. The second is the pace of growth in new income and job opportunities, such as the employment created by e-commerce platforms in food delivery or taxi hailing, he said. The third is the growth in per capita income, which is rising, according to government data.

The major challenge India faces is concerns net new investment, which has been depressed because liquidity challenges at banks have limited credit offtake, according to Kshirsagar. “[That] has prevented a large part of the engines of the economy, such as the small and medium enterprises sector and the supply chains, from growing and caused them to freeze up over the last two or three years,” he said.

Much of the pain caused by such liquidity challenges is “self-inflicted,” said Kshirsagar. “I look at this as corporate India driving itself into a ditch. About a year ago everyone persuaded themselves that the sky was about to fall.” According to him, while a few non-banking finance companies had “some deep-rooted issues” because they engaged in corrupt practices and fraud, the problem was blown out of proportion.

“We have taken what could have been an isolated set of issues associated with five or six institutions — a bank, an NBFC, a mutual fund and a couple of real estate development companies — and made it an economy-wide problem,” Kshirsagar said. “We have to get our confidence back because we got ourselves into this ditch. We have to jump out of it.”

The Indian government is trying to make financing available for infrastructure projects. One is the creation of the National Investment and Infrastructure Fund with investors such as the Abu Dhabi Investment Authority, Temasek of Singapore and the HDFC Group. The government has also announced Rs. 100 trillion ($1.4 trillion) in infrastructure projects covering the power, railways, urban irrigation, mobility, education and health sectors. Efforts to sell stressed assets of India’s public sector banks and divest government holdings in state-owned corporations are other encouraging signs. In the latest Union budget that was presented three weeks after the WIEF conference, the government set a disinvestment target of $2.1 trillion by 2021.

“We have to get our confidence back because we got ourselves into this ditch. We have to jump out of it.” –Alok Kshirsagar

India’s finance minister Nirmala Sitharaman recently claimed that the economy is returning to a sound footing, with “seven key green shoots” that are clearly visible, including foreign direct investment and foreign portfolio investment trends, industrial production and the purchasing managers’ index. A day later, two indicators dampened that enthusiasm: Retail prices rose to 7.6% in January, rising to its highest since 2014, and industrial output shrank by 0.3% in December 2019.

Growing Optimism?



Encouraging signs are visible are visible at toll plazas and tax collections that reflect activity in the informal and formal sectors, respectively, said Shailesh Pathak, CEO of L&T Infrastructure Development Projects Ltd. (L&T IDPL), the Chennai-based infrastructure development subsidiary of engineering and construction services company Larsen & Toubro. He noted that GST (goods and services tax) collections in November 2019 were up 6% and crossed Rs. 103,000-crore ($14.4 billion), reversing two quarters of negative growth, according to government data. They have since crossed Rs. 110,000 crore ($15.4 billion) as of January 2020, according to government data. “The true number that matters for the formal economy is GST collections,” he said. “Numbers don’t have ideology.”

Toll plazas offer a sense of the informal economy, noted Pathak, whose company operates 33 toll plazas across the country. “From the end of October onwards, the traffic numbers reveal that the worst is behind us,” he said. He noted that the formal corporate sector accounts for barely 14% of the Indian economy, and that most of India’s economic activity happens in the informal sector.

Across its toll plazas, L&T IDPL collects about a million dollars each day, Pathak noted. Of that, digital toll collections have grown from 2% in November 2016 to 64% as of early January 2020, he said. “This is not counted in GDP, but it has removed queues from toll plazas in our projects. There are 540 toll plazas in the country. Can you estimate the savings in those toll plaza queues in diesel, congestion and the waste of time?”

More and more of the informal sector is finding its way into GDP calculations, thanks to simplified tax regimes and a push towards greater compliance. “For a long time, the business model for many of these informal businesses was tax evasion,” said Pathak. “That’s not a sustainable business model.”

All that will doubtless boost India’s macroeconomic performance, said Pathak. “Whatever the GDP growth rate is next year, by 2024-2025, it will definitely be 300 basis points more than that,” he predicted. He noted that India overtook the U.K. economy in terms of GDP size last year, and said it would surpass Germany and Japan by 2029.

Speeding up Growth

“After India won independence [in 1947], it took 60 years to get to the first trillion dollars,” said Sujay Bose, CEO of the National Infrastructure Investment Fund. “The next trillion took 10 years and then from $2 trillion to $2.9 trillion took roughly three years. Now, in five years to do $2 trillion more is not out of whack; it can be done.”

Bose pointed out that the decade between 2005 and 2015 saw almost a trillion dollars of investments in infrastructure projects in the country. “The second trillion [can be achieved] faster if you do things the right way,” he said.

India is already moving up the leagues in some infrastructure segments, Bose noted. For example, over the next few years, the four largest global metro footprints will include three in China and in India (the fourth will be in Tokyo), edging out London and New York City. “If we can achieve that kind of directional investment in infrastructure, it becomes a key leg of the GDP growth to $5 trillion.”

Pathak said he thinks better days are ahead for India’s infrastructure sector also because the abuses of the public-private partnership (PPP) model in past years have declined and the government is coming down heavily on errant actors. “In India, PPPs became TTTs, or taxpayer-to-tycoon transfers,” he said. In such PPPs, an infrastructure project would be gold-plated with inflated costs that banks would fund, enabling private sector participants to take out their equity even before commercialization, he explained. “Obviously, when you run a $1,000 infrastructure project at a capitalized value of $2,000, you are not going to make money,” he explained.

However, if after completion, the project does generate positive cash flows and makes profits, the private sector partners would stick with it, he noted. “If it doesn’t [become profitable, the private sector partners] walk away. The banks carry the can.” Many of those PPP excesses occurred between 2006 and 2012, saddling public sector banks with nonperforming assets that are hobbling them till date, Pathak said. Since the government is reluctant to let public sector banks go under, it recapitalizes them with taxpayer money, he noted. “That is not a sustainable business model.” Bose expected the PPP concept to “re-emerge in a different way, with all the lessons that we have learnt from the previous decade.”

Pathak offered an alternative and sustainable way to operate infrastructure projects: Build them using government money, and once it’s a cash flow yielding asset, hand them over to the private sector to operate them. Mumbai and New Delhi airports are prime examples of private sector companies taking over operations after they were built with public funds, and they also make way for construction of additional terminals, he noted.

Butterflies and Caterpillars

Under-construction, public funded infrastructure projects are “caterpillars” and those handed over to the private sector for operations are “butterflies,” said Pathak. “Caterpillars are ugly to look at and full of risk. Butterflies are lovely, cash flow yielding assets for the next 30 years.” The upshot of that, according to him, is that “butterflies” will attract international funding because they have secure cash flows in sight, while “caterpillars” will find it hard to raise such capital. A second terminal at Mumbai’s international airport is a “butterfly”, since it is built by private sector partner GVK Power and Infrastructure, but the same company’s winning bid to build a greenfield airport in Navi Mumbai will find it challenging to attract international capital, he added.

Butterflies are clearly in demand, as recent deals show. Last October, NIIF and its partners Abu Dhabi Investment Authority and Canada’s PSP Investments signed a deal to acquire an equity stake of 26.3% each in the GVK group’s holding company that owns Mumbai international airport, for a total value of $1 billion. Pathak revealed that the Canada Pension Plan Investment Board, Canada’s largest pension fund, which last September bought a 51% controlling stake in L&T Infrastructure Development Projects, is “very clearly looking at butterflies” for its India investments.

“Caterpillars are ugly to look at and full of risk. Butterflies are lovely, cash flow yielding assets for the next 30 years.” –Shailesh Pathak

He said the government could open similar “butterfly” opportunities for investors in assets with existing cash flows such as railway stations. “If you have a footfall of 300,000 in a railway station, of course there is money to be made. The private sector would be happy to take it over.” On that note, he pointed out that a competition is underway between many Indian cities to build their own metros, and that in the next 10 years, at least 25 Indian cities will have state-of-the art metro systems.

As it happens, greenfield “caterpillar” projects are also attracting international investors. The NIIF combine with Abu Dhabi Investment Authority and Canada’s PSP Investments (a pension investments manager) will also get the rights to build the Navi Mumbai airport. NIIF’s other partner, Zurich Airport International AG of Switzerland, recently won the concession to build a second airport at Jewar near New Delhi. The Zurich Airport Group had in 2016 sold its stake in Bengaluru’s international airport to Fairfax Group of Canada. “We are actually able to get really serious, high-quality capital into greenfield projects,” said Bose. “This is a turning point in the infrastructure development picture in India.”

Investing in Infrastructure

Kshirsagar pointed to a few aspects that make India’s infrastructure projects more attractive to international investors than they were in the past. First, the presence of “large, professionally -run companies” such as L&T Infrastructure Development Projects and the emergence of NIIF as major funding platform is fundamentally changing the infrastructure market. Increasing transparency in governance and the use of auctions to allocate public resources have made it easier to attract international equity capital, he said. “As a fundamental premise of resource allocation, a huge change as occurred in the last five or six years [with auctions] as a way of allocating resources. When you look back 20 years from now, it will be a very important development to encourage more professional capital to avoid the gold-plating [of projects] and the tycoons’ corruption and political corruption.”

The push towards asset monetization at public sector organizations, such as the planned divestment at the state-owned logistics company Concor [Container Corporation of India], is driving “a lot of excitement from all the major global sovereign funds and global infrastructure investment funds to participate in that,” he added. “There is an important virtuous cycle occurring where the government is under pressure to do asset monetization, international capital is looking for butterflies, and you now have platforms and vehicles such as the NIIF through which to do that. I am optimistic about the combination of the market mechanism and asset monetization with a more transparent project pipeline to encourage equity capital.”

Role of State and City Governments

While most attention is focused on the central government, India’s state and city governments play an under-appreciated but crucial role in ensuring the success of infrastructure projects, the panelists noted. Kshirsagar pointed out that more than half of tax revenues in India are controlled by states. “Historically, when state-run corporations were run well, they had an enormous role to play,” he said. For example, the Tamil Nadu Industrial Development Corporation or the Maharashtra Industrial Development Corporation played an important role in land allocation and creating the ecosystems in their respective states in the 1950s, 1960s and the 1970s, he said.

However, decay has set in over the years at several state-owned corporations. “Unfortunately, most of them have in in the last 10 or 15 years have become huge sources of corruption and sweetheart deals, and there has been an atrophying of their capabilities,” Kshirsagar said. New structures such as special purpose vehicles (SPVs) to implement infrastructure projects have helped, and they are enabling many private sector companies to participate in smart-city projects including smart metering, water treatment and sewage treatment “that would simply have not been possible earlier,” he added. “Collectively, we need to raise that bar on [state-owned corporations] by using SPVs and other structures to encourage more private sector participation.”

“Read what the economists say but focus on what investors are doing.” –Sujoy Bose

According to Pathak, city governments represent an “even bigger risk” than state governments in infrastructure projects. “The way the state operates in India, the city is a subservient body. So, there is no champion for the city called Mumbai. It is the chief minister of Maharashtra who’s running Mumbai; it is the chief minister of Karnataka who is running Bangalore. This is not going to work.”

Another risk for investors in infrastructure projects relates to the enforcement of contracts, Pathak said. If contracts cannot be enforced, they will lead to time and cost overruns in projects, he cautioned. “In Singapore, if I give a check and it bounces, I go to jail. In India if my check bounces, it is the start of negotiations because nobody wants to go to court.” According to Bose, growing aspirations among Indian citizens for development, and the unrelenting pace of urbanization will drive a “bottom-up” push for infrastructure projects.

Looking Beyond the Numbers

Kshirsagar reiterated that GDP growth numbers are irrelevant, in response to a member of the audience who pointed to a Harvard research paper last year by India’s former chief economic advisor Arvind Subramanian. In that paper, Subramanian contended that between 2014 and 2018, India’s GDP had been overstated by 2.5 percentage points. Against official estimates of 7%, India’s GDP growth was no more than 4.5%, he had argued.

“What is powerful about Arvind’s paper is it looks at the underlying drivers of consumption and investment. And it did show that they were not growing,” Kshirsagar said. But since then, corrective mechanisms have been put in place such as with auctions of public resources, more transparent contract allocation and greater accountability, he added.

Reforms such as the introduction of the GST regime to unify the multiple taxes that prevailed earlier are important and positive structural changes, even if they were poorly executed, he added. GDP growth numbers represent the overall picture, but it is important to look for those that perform better than the average, such as states such as Chhattisgarh and parts of Madhya Pradesh that have done better than the industrial powerhouses of the past, including Maharashtra, Tamil Nadu and Karnataka, he said. The same is true for companies, where a select few high performers that are better governed will be able to take advantage of opportunities that transparent market mechanisms make available. “Forget the averages. Just look at where the growth is.”

Bose had advice for those about to start their careers or those who are in the early stages of their careers: “Read what the economists say but focus on what investors are doing. The largest and savviest investors in the world are allocating more and more of their capital to one, infrastructure, and two, to India. Forty percent of the largest investors in the world are saying that their top allocation of exposure is going to be for the infrastructure sector, and almost all the large institutional investors who operate outside the OECD countries have India as one of the top destinations of capital.”