Infrastructure: an India priority

Intro: India’s infrastructure spend at 3.5% of GDP is not only much lower than China’s spend at ~11% of GDP but needs to go up to at least 4% of GDP by FY12 if current growth rates are to be sustained. This would require an investment of over Rs12,265 bn across sectors over the next six years, even at a conservative estimate. But unlike in the past when most of the investment in infrastructure was made by the government, this time around the government has decided to act as a facilitator preferring to fund projects through public-private partnerships (BOT route). This has opened up several opportunities for private players and FDI investors with IRR as high as 25% even for low-margin infrastructure projects like roads. As for investors, with market capitalization of infrastructure companies set to increase by over US$100 bn over the next 3-5 years, returns would clearly outweigh risks in the medium to long term.
Base case scenario
Keeping gross capital formation (GCF) as a share of GDP and infrastructure spend as a share of GCF at its five-year average, we find that infrastructure spend corresponding to 7-8% GDP growth is likely to go up from Rs1,511 bn in FY06-07 to Rs2,664 bn in FY11-12 aggregating Rs12,265 bn over FY07-12.
Since gross domestic savings (household, corporate and public) is the main source of funds for infrastructure development, keeping the share of infrastructure spend to GDS constant, and assuming a 14% growth in the GDS rate (5-year CAGR is 12.6% but the growth rate has picked up over the last two years) one arrives at a sum of Rs15,263 bn (private sector savings of Rs14,500 bn + public savings of Rs763 bn) that is likely to be spent on infrastructure over 2007-12. FDI, the other source of funds for infrastructure development, is likely to contribute another Rs1,238 bn; even if FDI grows at a slower rate of 2% (as against 8% CAGR over the last 5 years), assuming 75% of the FDI goes towards infrastructure creation. This gives us a cumulative figure of Rs16,501 bn that is available for investment in infrastructure in a base case scenario.
Since Rs16,501 bn is available as against Rs12,265 bn that needs to be spent on infrastructure over the next 5-6 years to maintain current growth rates, even if GDP growth is higher than expected, infrastructure growth would be able to keep pace. However, these assumptions are based on a top-down analysis. Using a bottom-up approach (i.e. based on sector-wise outlays), actual spend on infrastructure could be higher at ~Rs14,000 bn over the next 5-6 years.
Estimates on sector spends based on outlays (Rs bn)

Sector Spend over FY07-12
Roads 1,520
Power 4,812
Railways 1,100
Telecom 1,227
Aviation 370
Ports 800
O&G 2,201
Urban infrastructure 1,974
Total spend 13,973
Source: RBI, Edelweiss research
RoadsCurrent status: India’s road network (3.3 mn km) is the second largest in the world and has witnessed an eight-fold increase over 1951-2004. However, over the same period, road traffic has increased by 22 times. Further, road infrastructure, especially highways (0.2 mn km network with 65,000 km of national highways, of which only 9% are 4-laned) has not kept pace with growth of user industries that depend on roads, considering that roads carry 70% of freight and 85% of passenger traffic, and needs to be expanded and strengthened.
Policies/Reforms initiated: While roads were opened to 100% private and foreign investment, the National Highways Authority of India (NHAI) constituted in 1995 for the development, maintenance and management of national highways undertook measures to boost private sector investment in road development. The 7-phase National Highway Development Program initiated in 1999 envisaged bulk of investments from Phase III to Phase VII to come from private sector participation. The private sector participant can either avail of a tolling concession or an annuity concession. In BOT-toll projects, the private sector meets the upfront cost and expenditure on annual maintenance and recovers the entire cost along with the interest from toll collections during the concession period. Apart from the 15-20 year concession period, a capital grant (subsidy) up to a maximum of 40% of the project cost is also provided by NHAI to the concessionaire. Annuity schemes under the Build-Operate-Transfer (BOT) projects mechanism allow risks and returns to be shared by the private developer and NHAI. The developer can charge an annuity to NHAI for building and maintaining the highway while NHAI is allowed to collect the toll. To encourage PSP, the government has also granted 100% tax exemption in any consecutive 10 years after commissioning of the project and allowed duty free import of construction equipment. So far 32 BOT projects valued at Rs47 bn have been taken up, of which 22 projects have already been executed. In all 37 projects valued at Rs235 bn (out of 55 to cost Rs312 bn) on offer under NHDP Phase II, III and V have been offered under BOT.
Growth potential: Roads are likely to account for ~10% of the total infrastructure spend or Rs1,500 bn over the next 5-6 years. Of this, ~60% is likely to be contributed by NHDP with bulk of the investment directed towards development of national highways and port connectivity (Rs931 bn) and the rest (Rs589 bn) towards maintenance / upgradation of existing highways. Around 95% of this investment will go towards construction and the remaining is likely to go to the input (cement and steel) and ancillary equipment space. Given the high GDP multiplier effect of 5-6 times that investment in roads have, roads would generate 3-4 times the road value for sectors dependant on roads while generating 2 times the value for contractors and developers. In other words, the Rs1,500 bn investment in roads would add Rs7,500 bn to GDP over the next six years. Early entrants with technical expertise in the BOT space would have high IRRs (Gammon India’s IRR is ~25%) while new entrants would have lower IRRs of ~15%. Given the lower IRRs, new entrants may take the securitization route (transfer beneficial rights in equity) post the development phase as Punj Lloyd has done.
Drawbacks/Risks: Low capacity and poor quality (on account of poor maintenance) are the two key issues that need to be addressed, rather than road length, for toll road projects to be viable and lead to economic growth.
PowerCurrent status: As in the case of roads, in power too though capacity grew 100-fold over the last six decades (85% of villages and 44% of households are currently electrified), supply has not matched demand with the gap at peak load exceeding 12%. While the poor financial health of SEBs have plagued the power sector on the one hand, lack of adequate investment in T&D have resulted in T&D losses mounting and adding to the existing power shortage.
Policies/Reforms initiated: Reforms in the power sector were initiated in FY02 and included one-time settlement of SEB dues, unbundling of SEBs (generation and distribution), permitting power trading, open access, widening the scope of participating in T&D under the accelerated power development and reform program (APDRP) and relaxation of norms for private investments in power transmission by amending the Electricity Act of 1910 and the Electric Supply Act of 1948. Permitting IIPs to sell power directly to end users and creation of a National Power Grid, so that inter-regional power transfers can take place, are next on the government’s agenda.
Growth potential: Given that India’s GDP is likely to grow at 7-8% over the next five years, power supply would have to grow at over 8% p.a. (as against 6% now) to gear up to meet the corresponding demand for power and power deficiency would have to be brought down to 5% from 8% currently. To achieve this, ~Rs236 bn would need to be invested in generation and Rs246 bn in T&D over 2007-12E. Thus, on an average, an investment of Rs800 bn p.a. would be required over the next five years as against Rs280 bn p.a. made between FY00-05. This investment in turn in likely to add ~60,000 MW of generation capacity over FY05-12 with the central utilities adding 36,000 MW of capacity (60%), private players led by Reliance Energy adding 16,000 MW and SEBs 8,000 MW. Though currently 2/3rd of the projects under execution are in thermal power (22,930 MW) as against 1/4th in hydro, the share of hydro power projects is likely to increase (to 1/3rd at the end of the 10th Plan) with hydro power projects gaining popularity with utilities and investors alike - e.g.1/5th of the incremental capacity being added by thermal power major NTPC is in hydro power. Also, of the 60,000 MW of generation capacity that is likely to come up over the next six years, ~40,000 MW will be on account of ultra mega power projects such as NTPC (17,000 MW), NHPC (3,955 MW) and Reliance (9,600 MW).
Drawbacks/Risks: Firstly, SEBs, which control bulk of the country’s power infrastructure, are plagued by huge T&D losses (due to under-investment in T&D), low revenue realization, un-recovered subsidies and huge outstanding loans to central PSUs. Secondly, private sector participation to date has been restricted and, despite policy changes initiated by the government, have yet to gain momentum. Thirdly, government has chalked out an over-ambitious target for the 10th Plan given its poor track record in meeting its earlier targets (it managed to achieve only ~40% of its planned target in 1992-97 and 1997-2002).
RailwaysCurrent status: Covering ~63,028 km (70% broad-gauge), the Indian Railways is the second largest network in the world and one of the world’s largest PSU employers. However, only 28% of the network is electrified and net ton km per wagon day is well below world standard. Saddled with a huge work force, the Indian Railways’ productivity per employee (net ton km + passenger km / employee) is also high in comparison to that of regional peers like China.Cross subsidization of passenger traffic by freight (freight generates 2/3rd of the revenues; average passenger fare to freight fare is 0.3%, one of the lowest in the world) resulted in freight traffic reducing and operating expenses mounting leaving the railways with no money to upgrade technology (improve speed) or improve safety standards. This in turn resulted in loss of revenue (as both freight and passenger traffic was diverted to roads) at the same time compromising safety and speed.
Policies/Reforms initiated: With a focus on improving safety, the government has set up a Special Railway Safety fund which plans to invest Rs170 bn over 2002-07 in replacing worn out assets. To improve port connectivity and strengthen the Golden Quadrilateral project, the government has meanwhile set up an SPV called the Rail Vikas Nigam Ltd (RVNL), which is likely to spend another Rs120 bn by 2008. The government is currently contemplating developing a dedicated rail freight corridor across Delhi, Mumbai, Kolkata and Chennai. The rail freight corridor along with a container corridor connecting the ports in Western India will involve setting up 9,000 km of railway tracks at a cost of Rs650 bn over the next seven years. Apart from this, rail infrastructure is likely to be improved under the Integrated Railway Modernization Plan (IRMP), which envisages an investment of Rs240 bn over five years up to 2010. The IRMP plans to introduce higher axle load, double stack container trains and light weight corrosion resistant aluminium wagons and modernize tracks with the latest signaling and telecommunications facilities so that passenger trains can run at 150 kmph and freight trains at 100 kmph along the Golden Quadrilateral and its diagonals.
Growth potential: The IR currently has 100,000 km of rail track (63,028 route km) and carries around 600 ton of freight. Given a freight multiplier of 1.25, at 6-7% GDP growth levels freight would increase to 1,000 ton in 5-7 years. This would necessitate an investment of around Rs1,200 bn (Rs600 bn in modernization including electrification, signaling and new coaches) and Rs600 bn in laying 30,000 km of fresh track over the next 5-7 years. However, as increase in freight volumes result in a sharp increase in revenues given insignificant incremental costs (high incremental capital output ratio), if the railways manage to attract higher freight traffic, it would result in higher ROCEs for the railways. Meanwhile, the Indian Railways employee rationalization programme, which targets trimming its workforce by ~16% over the next four years (up to 2010), would improve operational efficiencies.
Drawbacks/Risks: Huge pension liabilities accounting for ~15% of revenues and high overall staff costs (>40% of gross traffic receipts) along with poor productivity has hampered the profitability of the Indian Railways. Though the Rakesh Mohan Committee report has suggested rationalization of workforce (downsizing it by 1.2 mn or 1/5th by 2010), how this will be achieved remains unclear. As regards investment, though the Rail Vikas Nigam Ltd is implementing 53 high priority railway projects (aimed at improving port connectivity and strengthening the Golden Quadrilateral) for which it has proposed a spend of Rs120 bn up to FY08, most of the investments are still to be made.
TelecomCurrent status: India’s telecom network is the 3rd largest in Asia and the 8th largest in the world. The Indian telecom market has grown nearly four-fold (3.8x) over 2001-06 led by a CAGR of 100% plus in wireless or mobile subscribers (87 mn) which currently outnumber wireline subscribers (48 mn). The market size has been growing with telecom players increasing penetration in B and C circles. However, teledensity is low at 10% with 99% of rural population having no access to telephones. While urban penetration has increased to over 20% over the last 5 years, rural penetration is still very low at less than 2%.
Policies/Reforms initiated: While manufacturing of telecom equipment was deregulated in 1991, the telecom sector was liberalized in 1992 with the private sector allowed to provide value added services including cellular services. This was followed by opening up of basic telecom services in 1994 with one private operator allowed to operate in each circle (21 circles in all) and compete with DoT. In 1997 TRAI was set up as an independent regulatory authority and in 1998 VSNLs monopoly in providing internet services came to an end with private ISPs allowed to operate in India. This was followed with opening up of national long distance services to private operators in 2000 and international long distance service from India in 2002. With the government announcing a broadband policy in 2004, the composition of the internet market currently dominated by narrow band (only 10% of the 6 mn plus internet subscribers use broad band) is likely to change. Meanwhile, with the FDI limit in the telecom sector having been increased from 49% to 74% in 2005, the sector is likely to attract foreign capital especially in the telecom equipment space.
Growth potential: The telecom subscriber base is likely to increase to 339 mn by FY12 with 194 mn wireless subscribers and 10 mn wireline subscribers likely to be added over the next six years. The private sector would account for bulk of these adds ~142 mn. However, with penetration in rural markets likely to increase and upgradation of networks to support technology platforms such as WiMAX and Wi-Fi, capex requirements would be higher than in the past, at least for the next 3-4 years. Around Rs1.2 tn is likely to be spent on telecom asset creation over FY07-12 with Rs962 bn likely to be spent on wireless and Rs76 bn on wireline infrastructure. Given its high share in subscriber adds, the private sector (wireless) is likely to spend more on capex (~Rs817 bn up to FY12) than the public sector (wireline). The telecom equipment space is also likely to attract investments of Rs1.2 tn over the next six years with Rs733 bn likely to be spent on wireless and Rs311 bn likely to be spent on wireline equipment. Around 85% of this investment is likely to go into hardware (switching, transmission & cables) with the rest likely to be spent on telecom software. Among equipment suppliers, companies with exposure to specialized segments such as defence and space would be major beneficiaries once these two sectors are opened up.
Drawbacks/Risks: With competition intensifying especially in the mobile telephony and the equipment space and capex requirements likely to soar over the next couple of years, only players that can cut costs especially at the operating level, achieve economies of scale and rapidly upgrade to new technologies are likely to survive.
AviationCurrent status: From 5.1 mn passengers in the 1970s, passenger traffic has grown to ~60 mn passengers in 2005 while cargo traffic has increased from a mere 81 ton to 1.29 mn ton over the same period. Domestic air traffic has grown at the rate of 10% to 40.09 mn and international air traffic at the rate of 8% to 19.45 mn over the last five years (2000-05). Over the same period, international and domestic cargo traffic has grown at an annual rate of 12% (to 824,876 ton) and 6.5% (to 465,036 ton), respectively. However, of the 125 airports managed by AAI, only 85% are operational and 10 international airports handle 85% of the total passenger traffic and 95% of cargo traffic and generate 80% of revenues. Of the 10 airports, Delhi and Mumbai account for 49% of passenger traffic and 33% of revenues. Policies/Reforms initiated: In April 1990, the government introduced the open sky policy, which lifted restrictions on the number of flights and destinations that carriers could operate in. This was followed by repeal of the Air Corporation Act in March 1994, which ended the public sectors’ monopoly and enabled private operators to provide air transport services. In February 1995, six operators were given scheduled operator status. To deal infrastructure-related issues at international and domestic airports, in 1995 the government set up the AAI by amalgamating the International Air Authority of India and the National Airport Authority of India. AAI recently made changes in the Airports Authority of India Act to permit privatization of Delhi and Mumbai airports. As regards FDI policies, while FDI up to 100% is permitted in airports, FDI in domestic airlines is restricted to 49% with no direct or indirect participation by foreign airlines allowed.
Growth potential: A study conducted by CII-NCAER shows that for every 1% increase in GDP, domestic passenger traffic increases by 1% and international passenger traffic by 1.3%. Thus, domestic and international passenger traffic is expected to grow at an annual rate of 8% and 12%, respectively over FY06-12. As over 60% of the cargo is carried in the belly of passenger aircrafts and given increased momentum in trade, international cargo traffic is likely to grow at the rate of 8% and domestic cargo traffic at 14% over FY06-12. To be in a position to handle this traffic, utilization of airports across cities would have to improve and Delhi and Mumbai airports upgraded. The government has proposed to build/upgrade/modernize airports in 41 cities (including metros) over the next six years. Additionally, greenfield airports are proposed to be built in Mopa (Goa), Kunnur (Kerala), Navi Mumbai, Ludhiana, Chakan (near Pune), Pakyang (Sikkim), Kohima (Nagaland), Devanahalli (near Bangalore) and Shamshabad (near Hyderabad). The cost envisaged for the same is likely to be in the region of Rs370 bn, a large part of which would be construction expenditure. Going by the bids awarded for the Mumbai and Delhi airports, the private developer’s share in revenues is likely to be in the region of ~40%.
Drawbacks/Risks: Navigation charges continue to be 60% higher and fuel sales tax 80% higher than international benchmarks which increases the cost of operations of private airlines. Meanwhile, vast overstaffing (450/aircraft for Air India v/s 125/aircraft for a full service legacy carrier in the West and 394/aircraft for Indian i.e. Indian Airlines v/s 155/aircraft for Jet Airways) continues to impact profitability of PSU airlines.
PortsCurrent status: India has 12 major ports (which falls under the jurisdiction of the Union government) and 180 minor ports (which are under State government control) that handle around 77% of the total cargo traffic estimated at ~383.6 mn ton in FY05.
Policies/Reforms initiated: The government undertook privatization of ports in 1996 with the private sector allowed to (i) construct new facilities within existing ports, (ii) improve productivity at an existing port or (iii) develop new ports. In response to the government initiative, private sector investment in the port sector has been steadily increasing. To date, 19 projects involving an investment of over Rs64 bn has been approved and are already operational and another 17 projects involving an investment of Rs33 bn under consideration for approval. Since 1998, 100% FDI in the ports sector has also been allowed which has attracted foreign players like P&O which set up the International Container Transshipment Terminal at Nava Shava. The success of this venture in turn attracted other players like the Port of Singapore, Dubai Port Authority, Maersk Logistics and Stevedoring Services of America among others.
Growth potential: Port traffic has grown at a compounded rate of 8% over the last four years (FY01-05). Assuming the same growth rate continues, it would touch 950 mn ton by FY14. This would imply that capacity addition would have to grow at the rate of at least 9%. To achieve this, the government is currently implementing the National Maritime Development Programme (NMDP) that proposes to invest Rs603 bn in ports till FY14 taking capacity to ~915-920 mn ton. Around 65% of the investment being proposed is likely to come from the private sector, budgetary support is likely to provide 19%, internal resources 8.5% and the balance 7.5% likely to be met by rail and road connectivity projects.
Drawbacks/Risks: Though port efficiency has improved over the last five years thanks to private sector participation with the average turnaround time having reduced to 3.5 days in FY05 as against 8.5 days in FY96, productivity at terminals continues to be low, hinterland infrastructure facilities inadequate leading to poor port connectivity and delays at customs leading to higher lead times for trade. This has been the main reason why international shipping lines have avoided choosing an Indian port as a regional hub, preferring Singapore and Dubai instead. Also, though privatization has been allowed, privatized ports were forced to retain existing port workers, which hampered productivity. Further, the major ports (which control 75% of cargo traffic) are PSUs and lack autonomy in several operational matters which reduces their flexibility.
Oil & Gas Current status: India’s oil consumption at 2.32 mn bbl/day is met largely by imports of 2.09 mn bbl/day. Thus, with crude prices having moved up, gas has emerged as a more viable alternative. Currently, India has proven reserves of 5.7 bn bbl of oil and 853.5 bn cu m (853,500 MMCM) of gas. The oil & gas sector was highly controlled till 1992 but with approval of the New Exploration Licensing Policy (NELP) in 1997, the sector has been steadily opened up.
Policies/Reforms initiated: To allow equal opportunity to the private sector in exploration, in March 1997 the government approved NELP. In 1998, pricing controls in the refining sector were removed and in 2002 the Oil Pool Account (for E&P) and Administered Pricing Mechanism (for marketing) dismantled. In 2004, FDI in E&P and marketing was increased to 100%.
Growth potential: Within the oil & gas space, demand for natural gas is likely to grow the fastest. According to the India Hydrocarbon Vision 2005, the demand for natural gas is likely to be 322 MMSCMD by FY25, assuming a rate of US$ 4/MMBTU for imported natural gas. With crude prices rising and demand for oil and gas on the increase, the sector is likely to attract investments of ~Rs2.3 tn till FY12. Most of these investments are likely to be in the exploration & production (Rs861 bn; 38%) and refining space (Rs679 bn; 30%), but a significant amount is also likely to go into petrochemicals (Rs341 bn; 15%) and building pipelines (Rs199.6 bn; 8.7%). Drawbacks/Risks: Rising crude prices have not only brought ongoing reforms in the oil & gas sector to a standstill, but, with the oil companies’ inability to pass on the price increase to consumers, led to huge under-recoveries. As a result, oil marketing companies suffered losses while upstream companies saw an increase in subsidy burden so that investments even in planned projects have been delayed.
Urban infrastructureCurrent status: World over there exists a strong co-relation between per capita GDP growth and urbanization. With per capita GDP growth on the back of expansion in services and manufacturing industries picking up, urban population has grown at a rate of 8% over the last five years from 285 mn in 2001 to 307 mn in 2005. With strong growth in services likely to continue, urban population is estimated to reach 550 mn by 2021 and the share of urban population to total population likely to go up to 41% from ~28% currently. Growth in urban population is likely to see an increase in demand for housing, which in turn will necessitate a corresponding investment in water and sanitation facilities. However, despite the contribution of urban India increasing in India’s GDP, investment in urban infrastructure has been abysmal – at 0.6% of GDP (v/s 4%+ in other developing countries), public expenditure on urban infrastructure is one of the lowest in the world.
Policies/Reforms initiated: As urban infrastructure development failed to keep pace with GDP growth, the National Urban Renewal Mission (NURM) was launched in December 2005 to address integrated development of urban infrastructure services (primarily housing, water supply, sanitation and slum improvement) with assistance from the Centre, state and local bodies. The Mission will cover 60 cities likely to have a 1mn plus population over the next 6-7 years and invest Rs837.1 bn over FY07-12.
Growth potential: Apart from the Rs837.1 bn that has been earmarked for development of urban infrastructure under the NURM, metros would require an additional investment of Rs505 bn, SEZ development will need another Rs392 bn and investment in land development for commercial and residential properties another Rs181 bn over FY07-12.
Drawbacks/Risks: Apart from a housing shortage (which is widening), urban India also has poor sanitation (less than 63% of urban India has access to sanitation as against the developing world average of 75%) and low drinking water availability (only 85% of urban population has access to drinking water as against 95% which is the developing world average). If urban population continues to grow at the current rate, urban India could well head for a water scarcity by 2050.
Construction companies will benefitOf the Rs14 tn likely to be spent on infrastructure development over the FY07-12, nearly 42% (~Rs6 tn) is likely to be spent on construction. The highest construction spend as a share of total spend is likely to be made by roads (Rs1,444 bn or 95% of total spend) followed by the urban infrastructure segment (Rs1,406 bn or 71% of total spend). The lowest expenditure on construction is likely to be made by the telecom sector (Rs61 bn or 5% of total spend). Operating margins (OPMs) will however be lowest for road projects (~6%) and highest for telecom (>25%). The construction sector’s revenues are likely to gather momentum over this period as construction activity moves from completion of existing projects to new project execution and companies move up the value chain i.e. from contractors to developers-cum-operators. Thus, the industry is likely to see revenues grow from Rs731 bn in FY06 to Rs1.2 tn by FY12 at a CAGR of ~8%.
Cumulative sector wise spend likely over FY07-12 Rs bn

Sector Total spend likely Construction spend Const. Exp/ Tot. Exp (%)

Rail 1,110 440 40
Ports 800 320 40
Oil & gas 2,201 220 10
Power 4,812 1,837 38
Telecom 1,226 61 5
Road 1,520 1,444 95
Aviation 370 185 50
Urban infrastructure 1,974 1,406 71
Source: Edelweiss

Article Author: Manish Marwah