India’s electricity sector provides a good case study of the country’s development process. The sector is rife with problems – there is a shortage of supply, and the infrastructure is generally controlled by poorly managed and often corrupt public utilities agencies.
Beyond that, a protectionist attitude has, in the past, kept reforms from taking hold. For example, the coal used to produce electricity is generally supplied by one of just two public firms. And to top it all off, demand is spotty because people often steal the power than pay for it – in 2000, 40% of the electricity distributed across the country was never paid for.
Now, however, a number of states have taken steps towards bringing private sector resources into the electricity market through public private partnerships (PPPs). One is Maharashtra state which, starting this year, has outsourced the distribution of electricity in urban centers in a revenue sharing model.
“Private players are getting involved. Hesitations that they had earlier don’t seem to be that binding,” said Dr Montek Singh Ahluwalia, vice-chairman of the Planning Commission of India.
“There have been many competitively-bid PPP projects where private sector generators have been established to sell electricity to the utility even if the utility is not in the best of shape.”
State support
Increasing participation from the private sector has coincided with an increase in infrastructure investment by the state governments. It is evidence that the priorities set out by the central government in the country’s 11th Five-Year Plan are filtering down.
The overall result is that electricity production is on the rise. Supply is expected to grow by 6% per year between 2007 and 2012 – double the rate of growth of the past five years and the second largest increase in absolute capacity in the world.
“I think the private sector is willing to give the benefit of the doubt to the system in terms of anticipating that improvements are underway and that the electricity they produce will be paid for,” said Ahluwalia.
Opening up
A boost in private participation in the power sector would surprise nobody looking at a wider increase in private sector involvement across the economic board. The central government has already opened up a number of sectors, notably airports where PPPs in Delhi and Mumbai have paved the way for some half a dozen similar efforts across the country.
At the same time, Delhi has also reduced barriers to entry in several service industries such as accounting. A similar move is now even being considered for legal services.
If the goal is economic growth, liberalizing entire sectors of the economy makes sense. According to the first economic survey of India by the Organization for Economic Cooperation and Development (OECD), liberalized sectors do better than those that remain firmly under government control.
“The impressive response of the Indian economy to past reforms should give policy makers confidence that further liberalization will deliver additional growth dividends and foster the process of pulling millions of people out of poverty,” the OECD observed.
This impressive response saw India’s GDP top US$1 billion last year with per capita GDP coming in at US$812.
As measured by purchasing power parity, the subcontinent has the third largest economy in the world, behind the US and China and just ahead of Japan. By the same measure, per capita GDP was US$3,452.
According to the OECD, “annual growth in GDP per capita has accelerated from just 1.5% in the three decades after independence to 7.5% currently.” The government wants to see this figure jump by a couple more percentage points, a goal that seems achievable.
Tariffs are down to an average of 10% and are likely to continue dropping, while both exports and imports are exhibiting strong growth. Inflation was relatively high but the government is expected to be able to keep it within the 5-5.25% target range in the coming year.
Overall, it seems a good time to invest in India.
“In the last four or five years, the Indian economy has not only been a good economy but also a maturing one,” said Dr Amitendu Palit of ICRIER, a New Delhi-based think tank that worked with the OECD on the economic survey. “From the early 1990s you had a different set of policies coming in followed by a quick response. What we are going to see next is a much more confident India.”
Challenges ahead
The hurdles that remain, besides the overwhelming task of developing a country with 1.1 billion people, are systemic.
There are too many laws that are often poorly defined and leave a lot of gray areas. Courts are backlogged and there is a shortage of effective dispute-resolution mechanisms that would give businesses confidence to dive into the market. There are also remnants of a long-standing protectionist approach to the economy as well as a strong vein of public ownership.
According to the OECD: “There is a large tail of loss-making public enterprises, particularly at the state level, and on average the productivity and profitability of publicly-owned firms have been lower than in the private sector. Privatization would thus appear to offer considerable possibilities for improving productivity.”
However, the organization’s warning that privatization is stalling because the focus is on selling minority stakes rather than transferring control of inefficient public enterprises, is not supported by Ahluwalia. He believes that privatization should follow a carefully thought out strategy and should not be done just for the sake of privatizing.
“I don’t really believe that the high degree of public investment, or rather public ownership in certain sectors, is a critical constraint on growth,” said Ahluwalia.
Neither does he believe that privatizing large parts of the economy would be a practical or a popular option.
“While the public doesn’t mind liberalizing … privatizing in the sense of selling off existing public sector enterprises, would probably lead to more controversy than it’s worth,” he said.
If current investment patterns go on, though, investors are likely to continue looking for opportunities to sink money into the subcontinent.
In a recent report focusng on the economic relationship between China and India, Jing Ulrich, chairman of China Equities for JPMorgan, noted that foreign direct investment (FDI) into India more than doubled in 2006 to US$12.07 billion and was on track to repeat the trick in 2007. During the first half of the year alone, FDI hit US$12.3 billion.
On the other side of the coin, Indian companies are also becoming more involved in the world economy. Outbound investment deals came to US$15 billion in 2006, triple the previous year’s total. It could reach US$35 billion in 2007.
Cut the red tape
But for this to happen, the Indian government may have to take further steps to reduce barriers to investment and growth. According to the OECD, getting rid of obstacles to a truly competitive environment would enable India to maintain its current growth rate.
Beyond that, the country needs to look closely at the impact of new and existing laws.
One of the first areas that may require attention is employment law. The OECD concluded that India’s labor legislation is more draconian than that of Brazil, Chile, China and all but two OECD countries. Much of the employment growth to date has been within small companies not covered by these laws. These firms have also had a strong track record in attracting investment.
Overall, though, the country has made considerable strides in growing its economy, reducing regulatory barriers and improving standards of living at all levels of society.
“Between 1999 and 2004, the absolute number of people living under the national poverty line has fallen for the first time since independence,” the OECD pointed out in its report.
Heading into 2008, that seems likely to continue. Investors are as interested as ever in the country, and the government appears committed to continuing reforms. As things stand now, the largest potential pitfalls appear to be external.
As Ahluwalia notes: “As long as the sub-prime crisis doesn’t send the industrialized financial system into a real tailspin, the type of growth we are targeting, which is 9%, should be achievable given India’s circumstances and conditions.”