Funding Infrastructure: A Closer Look at the Financial System Structure of India

Developing infrastructure lies at the core of any strategy for achieving sustainable economic growth of a country. Economists have described infrastructure as a key ingredient for both growth and productivity since the time of Adam Smith. According to the World Development Report, 1994, the adequacy of the infrastructure of a country is a major determinant of the country’s success in diversifying production, expanding trade, coping with population growth, reducing poverty, or improving environmental conditions. However, financing investment projects remain a key challenge for countries across the world and developing countries in particular, mainly due to their limited ability of public spending and relatively underdeveloped financial markets. Investment in infrastructure is different from any other investment, due to three key reasons. i) these investments are lumpy in nature and involve uncertainty due to long gestation period ii) investment in infrastructure involve externality and coordination with multiple stakeholders, including government and regulators ii) large infrastructure projects often involve significant environmental and social risk. Due to its unique nature, investment in infrastructure involves a crucial role of Government. Notwithstanding, private participation in infrastructure development has increased significantly worldwide during the last decade due to increased usage of innovative project management techniques. Another factor that contributed to the upsurge of private investment in infrastructure is increased participation by pension funds, mutual funds, exchange-trade funds, insurance funds, private equity funds, hedge funds and sovereign wealth funds in financial systems across the globe (World Bank, 2012). However, despite having great potential, private sector financing remains highly volatile to financial crises and is concentrated in a few sectors and countries. This, in turn, has widened the disparity of infrastructure development between the middle income countries (MICs) and the low income (LICs) countries. The MICs have a developed financial system and a wide range of investors. As a result, these countries have attracted huge private capital in infrastructure during recent times. In contrast, the share of private investment in infrastructure is abysmally low in LICs. Hence, financing infrastructure remains as one of the greatest challenge for these countries. The interconnectedness of financial systems and the adoption of global regulatory practices and capital accords has been a key driving force behind changing pattern of infrastructure finance in developing countries during recent years. Though the association between financial system structure and investment flow to infrastructure has become even more visible during recent years, there is a dearth of empirical research on this issue in the context of India. This paper provides an analysis of infrastructure investment in India, the key issues involved in funding infrastructure projects through the existing form of financial markets in India and concludes with key findings and policy implications drawn from the analysis.