Economic Reform and Infrastructure

As prepared for delivery

I want to thank Mr. Amit Mitra and his colleagues at FICCI (Federation of Indian Chambers of Commerce and Industry) for inviting me to speak on Economic Reform and Infrastructure. I also want to congratulate FICCI and the Department of Industrial Policy and Promotion for organizing this event on Infrastructure, an issue of critical importance in India today.

India's new government is clearly bent on implementing economic reforms. These of course must be politically possible to achieve, and they must enjoy sufficient consensus to survive.

We acknowledge these realities and seek to concentrate on what I would call strategic reforms that have major "fall out" throughout India's economy. These are not areas of dispute. Rather, these are challenges where the U.S. and India have a strong mutuality of interests and the U.S. can be a significant contributor to India's progress.

Infrastructure is clearly one of them. It is, I believe, a widely acknowledged fact today in India that a world-class infrastructure will be needed in India to provide the platform for faster, consistent growth and for India to become a major world economic power. Moreover, there will be lasting political support for those in power who provide infrastructure that India's rural population and urban dwellers can touch, can feel and use to improve their lives.

Building a world-class infrastructure in a relatively short period of time is a very tall order for any country to fulfill. We all know that economic reform can be social and political dynamite. Coalition governments are notoriously difficult to manage, even when there is an agreed roadmap of common minimum policies.

If building a world-class infrastructure in India is truly to be a priority of the first order, there are two obvious conditions that must be met. One is overriding clarity of purpose. The other is courageous political leadership dedicated to accomplishing the mission.

India has successfully implemented a first generation of economic reforms - the Watershed being 1991. The results are there for everyone to see. One hundred million people lifted out of poverty since 1991. Growth rates of 7-8 percent, rather than 3-4 percent prior to 1991. A growing middle class with even faster growing disposable income. More consumer choice. Over $140 billion in foreign exchange reserves. $70 billion in exports. The India IT sector is the fastest growing part of the fastest growing industry in the world. An IT sector, which has transformed India's image overseas. An assertive and self-confident business class.

These accomplishments are most impressive. But the unanswered and increasingly serious question is: How can India sustain 8% plus annual growth, reform its agricultural sector, improve education and health care, open its economy to the benefits of globalization and emerge as a true world power if it is constrained increasingly by inadequate infrastructure development. Infrastructure is not the last area one develops in an era of great economic progress. It is, at the very least, an essential part, and often a prior condition, for great transformation.

Fortunately, this reality appears to be recognized at India's highest levels of leadership. It's now time to put ideology to one side and focus on practical "steps that work."

"Steps that work" must be based on a frank recognition of realities. These have to do with why the government must press ahead with fundamental economic reforms, many of which involve questions of governance. What are some of these realities?

Public sector participation in the economy remains large. The fiscal deficit is too large and causes government to preempt much needed investment capital from use by the private sector. Direct and indirect subsidies drain away resources from priority investments in education, health and infrastructure. Labor markets are restrictive and inflexible. Regulatory procedures are opaque in the eyes of foreign investors and therefore a disincentive to entry. The Indian economy remains highly protected. FDI caps in many sectors continue to dampen investment flows into India. A world class IPR protection regime in the making but we must see how it works in practice - will it promote investment and growth?

Building world-class infrastructure involves a multitude of complexities. Taken together, they can be quite overwhelming. Hence, my two-point admonition - clarity of purpose and courageous political leadership.

We know that improvements in "human capital," such as better education and health care are important contributors to infrastructure creation.

So are the familiar "bricks and mortar" industries like roads, ports, airports, water and sewage systems, transportation facilities, crop collection, cold storage and distribution for farm produce, telecommunications and yes, a national gas grid.

Collectively these form the physical platform for future economic growth. If they are non-existent or sub-standard, future growth will be hampered and that includes co-production prospects for sophisticated military aircraft. Job creation will lag, services will suffer, poverty reduction will falter as population growth proceeds - and in general, public dissatisfaction with both infrastructure and politicians will rise.

Building a world-class infrastructure in India also requires that Federal-State political, institutional and policy diversity be addressed. Hence, again, the need for clarity of purpose and political leadership willing to spend its political capital. When a nation decides to win a war, unity of purpose is essential and all efforts are bent to achieving that objective. Infrastructure needs a similar commitment.

Let us therefore ask, if there is unity of purpose, what are the "steps that will work?"

First, differentiation amongst different elements of infrastructure, prioritizing those projects that have the most far reaching fall out for the economy. The government has begun to do this and should get credit for their effort. The air transport industry is a good example.

Second, sorting out those elements of infrastructure that can be developed immediately and primarily by private capital. Telecommunications is already an obvious example. Power and airports are other examples. These areas require further liberalization under a strong, dependable, but enlightened regulatory regime. Private capital is key here together with world-class standards of governance.

Third, those areas that require a major change in public attitudes must be approached head on by political leaders. Water and electricity are cases in point. World-class infrastructure that delivers clean water effectively to the public cannot be built and successfully operated unless water is priced. This may challenge existing attitudes, but it is nevertheless the reality. Priced water has already been demonstrated to be doable and successful in India, but the problem is (a) scale of effort, (b) time required to make progress, (c) removal of political and regulatory obstacles. These are all matters that come back to clarity of purpose and political will.

One could go on, listing different elements of infrastructure and various projects. However, at the end of any such exercise one would be left with a handful of central issues that apply to the entire infrastructure challenge.

I wish to focus especially on those issues that impact the U.S.-India relationship. I have said earlier that we have a strong mutuality of interests, and this is certainly true when it comes to foreign direct investment and further development of India's capital markets.

I strongly believe that infrastructure challenges cannot wait; yet the public sector cannot now provide the necessary finances for India's infrastructure needs. India must therefore invigorate, as a matter of priority, private sources to finance long-term project development, which inter alia means that federal and state regulations and attitudes that inhibit private investment in infrastructure must be changed. Meanwhile chronic budget deficits at both the federal and state levels must be reduced. Capital will have to be freed from wasteful subsidies and India's financial markets will need further liberalization. Developing a truly long-term capital market must be a key objective for government, which through greater fiscal restraint and creative financial engineering needs to reduce its own crowding out effect in India's financial and banking systems. India's insurance and pension industries hold out important hopes for mobilizing long-term capital from India's abundant savings base. Lifting the ceiling on foreign direct investment in insurance would clearly help, as would expanding and liberalizing as a matter of urgency India's emerging pension industry. So too would reducing government's dominance in the banking industry, together with stronger encouragement and greater freedom for the growth of private domestic and foreign banks. If private capital is going to play a key role, financial liberalization must happen now.

India should open up its retail, real estate, finance, and agro-processing industries to attract new investment. States should abolish restrictions on the private marketing of agricultural commodities. The Government should repeal the Essential Commodities Act and the Agriculture Produce Marketing Act. They are relics from the time India feared famines. Agricultural processing, storage, refrigeration, and marketing have received too little private investment in large part because of government disincentives and inefficient infrastructure and marketing networks that reduce returns to such investment. This has impeded the development of the large scale national markets needed to repay investment in infrastructure.

Lifting of such restrictions will enable national markets to flourish. Viewed from the perspective of U.S. investors, India has not reached its potential as a great emerging market because it is not a national market. Instead, restrictions and prohibitions on interstate trade mean that India is really a conglomeration of regional markets - most of which lack the size, depth and financial prowess to attract new large scale investment.

National markets need national infrastructure systems to sustain them. As the regional markets evolve into a national market, you will see that there will be a greater pressure for systems such as a national gas grid, a national highways system, and an expanded aviation network. As these regional markets grow, so will the attractiveness of India as an investment destination.

When it comes to investment, whether foreign or domestic, a "culture of consistency" is vitally important.

If one changes the rules in mid-stream on a project already agreed, and which requires a lengthy period for execution, or even if newly arrived political players decide to put the on hold for review, one will quickly lose credibility with those providing capital and executing the project. The time for review is before the award. After the award is the time for "no nonsense" execution.

This is a reality of first importance and one that is vital to address if India is to build world-class infrastructure as a matter of priority in partnership with private capital. This reality applies equally to both domestic and foreign players. Domestic players may have more patience with national bureaucracy than foreign investors, but it is very clear to me that one reason Indian investors don't comfortably buy long term debt (15 years and longer) or enter into similar long-term commitments secured by government initiated payment flows is that in general they do not have faith in the durability of commitments from government entities here at home.

Developers and providers of capital with large sunk costs over long periods are left in limbo when reviews, reversals or changes in terms of engagement move to center stage. Moreover, the reputational damage for India spreads far and wide, acting as a brake on future investment commitments.

I believe there is a need for some sort of political consensus in India on creating a "culture of consistency" that governs infrastructure projects. Once again, it is a question of clarity of purpose and courageous political leadership. It is also a question of governance. Preparations for projects must be thorough, procedures disciplined and transparent, and awards must be final and faithfully honored by the authorities involved, and their successors. When disputes or failures to perform arise, there must be timely and decisive arbitration and/or court action to enforce rights and obligations.

To support this effort, it is necessary to promote these standards in India's financial markets. One way to do so would be to create a significant new financial guarantee entity, owned and operated by private sector personnel, but enjoying a measure of government and multi-lateral support. This entity could offer guarantee support for private financing of large-scale infrastructure projects, requiring long-term capital financing, and in doing so, impose the necessary standards of compliance, transparency, and legal follow-through to overcome India's present lack of confidence in long-term capital project commitments.

In any case, the future is here, the challenge is now. India is clearly emerging as a world economic power, and this week you have seen the commitment of the United States help India become a major world power. This involves infrastructure creation, but also energy, high-tech commerce, innovative use of science and technology, and military cooperation.

I hope you agree that these are exciting times.