In August 2021, Government of India announced an asset monetisation plan wherein existing public assets worth Rs. 6 trillion would be monetised by leasing them out to private operators for fixed terms, and the proceeds would be used for new infrastructure investment. In this post, Amartya Lahiri examines the revenue potential of this plan, and whether it is likely to enhance the efficiency of the economy.
The Government of India recently announced an asset monetisation plan wherein existing public assets worth Rs. 6 trillion would be monetised by leasing them out to private operators for fixed terms. The identified assets are primarily concentrated in roads, railways, power, oil and gas, and telecoms. The lease proceeds are expected to be used for new infrastructure investment which, in turn, will contribute to the government’s ambitious Rs. 111 trillion infrastructure investment plan.
The plan has generated a lot of print, so it is worth discussing its pros and cons. Though there are many important issues raised by the plan, for brevity, I will confine the discussion to two issues: (a) How much should the government expect to raise from the plan?, and (b) Is the plan likely to increase the efficiency of the economy?
Uncertain revenue potential
In deciding the amount to bid for leasing rights, bidders compute the present discounted value of the annual cash flow from the asset for the duration of the lease. The biggest uncertainty in this calculation is around the cash flow on these public assets. Rates of return estimates on public capital in the US have been estimated to be upwards of 15%. However, this is India – with its myriad uncertainties regarding pricing, bill collection, asset quality, regulatory framework, as well as policy reversals. Consequently, the risk-adjusted returns on public assets in India are likely to be lower than the US estimates.
To get a sense of the potential revenues at stake, note that with a 10% annual real return for 30 years and a 5% real discount rate, the discounted cash flow on Rs. 6 trillion public assets is Rs. 9.7 trillion (without discounting the first year’s cash flow). A desired cumulated 100% profit over 30 years – which corresponds to an annual profit rate of 2.3% over a 30-year period – would imply that investors would bid around Rs. 4.85 trillion for the leasing rights.
Small variations in the assumptions underlying the calculation above however, can have drastic effects on these estimates. A reduction of the annual real return to 6% would reduce the discounted cash flow to Rs. 5.8 trillion and the amount investors would bid would reduce to Rs. 2.9 trillion. Similarly, raising the expected annual profit rate to 5% (a cumulated 340% profit over 30 years) would reduce the bid to Rs. 2.2 trillion on assets yielding a discounted cash flow of Rs. 9.6 trillion.
This range of revenue estimates suggests that there is significant uncertainty regarding the revenue potential of the plan. But crucially, even in the most optimistic scenario, the revenue generated by this plan is unlikely to exceed 5% of the government’s overall infrastructure investment target of Rs. 111 trillion. Hence, its revenue potential is limited.
Scope for efficiency gains, but significant impediments too
The second question is whether the plan will enhance the efficiency of the economy. The NITI Aayog believes that the private sector is better than the public sector at managing and operating the identified public assets. In as much as that is true, there is certainly scope for efficiency gains. However, there are significant efficiency impediments too.
A first set of efficiency issues surround usage fees. Can the lessee freely choose the price of the services from the asset? If so, could we end up seeing significant increases in prices? This is one of the salutary lessons from the Australian state of New South Wales’s experience with privatising its electricity distribution.
Another efficiency issue of the monetisation plan is the maintenance of the assets. Since successful bidders will not get title to the asset but only get the right to extract revenues from it, how incentivised are they going to be to maintain the asset? When users do not own the asset, wear and tear is inevitably greater. Consequently, longevity and quality of these public assets may not be optimised under the plan. Indeed, lack of maintenance and declining service quality are often ascribed as the reasons for the failures of the rail network privatisation in Britain and Singapore.
On the flip side, users who do not have to maintain the asset might be willing to bid more relative to buying the asset outright. Assessing this trade-off along with the incentives of successful bidders to maintain the assets depends on the specifics of the leasing contracts, specifics that the currently announced plan is short on.
A third factor related to efficiency is the effect of the plan on competition. Could the plan induce the cartelisation of key segments of the infrastructure landscape? The identified assets belong to core sectors of the economy spanning transport, energy, and communication. Sectors like telecoms and ports have already seen rising concentration of ownership in recent years. An acceleration and extension of this trend to other segments of the infrastructure landscape would be seriously worrying. While some of this could well be rationalised through the stipulation of rules for the allocation of leasing rights and for ensuring competition, the plan is silent on these.
A fourth set of efficiency-related issues pertain to the financing of the lease bids. If bidders finance their bids using domestic savings, there is a clear opportunity cost of the plan since these savings would otherwise have been invested in alternative projects. Moreover, the bidding for scarce domestic savings by prospective investors will also raise domestic interest rates, which will put downward pressure on domestic private investment. It would also be worth remembering that the last round of PPP (public private partnership)-based infrastructure funding routed through banks ended up with a heap of NPAs (non-performing assets) in public sector bank balance sheets.
The way around this is to welcome foreign investors to bid for the assets. But this will require serious political will as entrenching foreign influence on Indian public assets will generate controversy. On this aspect too, the announced plan is low on details.
More generally, the monetisation plan envisages the private sector paying an upfront fee to the government, which the government uses for new infrastructure investment. In as much as private bidders finance themselves by borrowing, this amounts to the private sector borrowing and handing over the funds to the government to invest in infrastructure. This would enhance efficiency in infrastructure investment only if the government faces higher interest rates in capital markets than the private sector. But this is not true since the government actually borrows at lower rates than the private sector.
Given the lower borrowing cost of the government, an alternative approach to monetising these productive public assets may be for the government to collect all the identified assets into a public sector infrastructure holding company and then issue infrastructure bonds of 30-year maturity whose coupon payment is based on the cash flows of these assets. These bonds should place at lower yields given the implicit State guarantee and the diversified revenue stream of the underlying assets. Moreover, they might actually attract more foreign institutional investors like long-horizon pension funds.
Need for white paper
Perhaps the biggest drawback of the announced plan is that it fails to articulate the reasons for public sector inefficiency in asset management. If it is personnel related, then privatising management may be the right answer. If, however, the inefficiency is related to constraints on pricing and bill collection then the roots of the problem are unlikely to be addressed by leasing out their management to private operators.
The plan document also fails to outline whether the identified brownfield assets1 are the public sector’s highest cash flow assets or the relatively under-performing ones. If the private sector is indeed more efficient in running infrastructure assets, the most efficient strategy would be to lease out the worst performing assets rather than the best performing ones.
The NITI Aayog would do the policy landscape a big service by following up the proposal with a white paper which addresses some of these efficiency-related issues. Without that, the monetisation plan, while intriguing, is incomplete.
A version of this article has appeared in the Indian Express.
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- A brownfield asset is a developed asset that however, may need ongoing capital expenditure and expansion.