A 2012 study of 22 nations by Prof Miles Corak for the Organization for Economic Cooperation and Development (OECD) has found income heritability (likelihood of success being inherited rather than being earned) to be greater in the United States, United Kingdom, Italy, China and five other countries than in Pakistan. The study identified three key drivers of inter-generational mobility: family, labour market and state. The biggest difference that the family can make is in terms of education and training of its children, while a growing labour market is important for the availability of better paying jobs and lastly, the state matters because its policies influence access to education and growth of opportunities. Collectively, this presents good news for us, but when you separate the three in case of Pakistan, our weakest link over these past five years has been the state which has failed to adequately fund education and facilitate economic growth through infrastructure development.

China and India, on the other hand, in recent years have focused strongly both on education and infrastructure development as the main drivers of their growth and as a result have better results to show in terms of poverty reduction, employment generation, more equitable distribution of resources and sustainable development. For the sake of this article and bearing in mind the South Asian regional relevance, I would like to particularly highlight our neighbour India’s endeavour on using infrastructure development as a priority tool in their economic plan and more importantly their prudence in managing the resource requirements essential to undertake this rather capital intensive drive. The challenges in funding the construction and modernization of India’s infrastructure, as everyone knows, are huge. The key challenge, however, pertains to the sheer magnitude of investments required. Unlike the West, India’s under-developed bond market thus far has been unable to effectively channelise funds from potential long-term investors into this sector and as a result the banks have until now been the primary funding source for infrastructure despite the mismatches in asset-liability profile inherent in this business.

So what have the Indian economic managers exactly done to change all this? They decided to turn proactive and innovative in October 2012 by taking two bold steps. First, they have as a policy started engaging their main trading partners with whom India runs a trade deficit (primarily China, Japan and South Korea) by working with them on mutual currency swaps and convincing them to leave their surpluses in India through investment in India’s fast growing infrastructure needs. The attraction for them being that not only does this investment allows them to earn a much higher net return than they would otherwise have earned as interest on the USD (US Dollar), but also provides them the diversity they seek in their reserves cum investment basket in shifting the dependence away from the USD - thereby reducing the single currency risk. Second, they have developed a source for long-term funds for India’s infrastructure sector – Infrastructure Debt Funds (IDFs). These funds are designed to address some of the main issues of this sector by facilitating the flow of low-cost, long-term funds to capital intensive infrastructure projects.

IDFs that are structured as non-banking finance companies (IDF- NBFCs) will be regulated directly by India’s Central Bank, the Reserve Bank of India (RBI). The funds will bridge the gap between the low-risk appetite of India’s bond market investors and the relatively higher credit risk associated with infrastructure projects. Today, even post-construction, the credit profiles of projects are usually lower than the threshold expectations of the bond market. IDF-NBFCs will achieve this primarily by lending to infrastructure assets of good quality, supported by an effective credit enhancement mechanism. In a bold move to encourage transparency and efficiency, RBI permits IDF-NBFCs to invest mainly in public-private partnership (PPP) infrastructure projects. However, only in a PPP that has completed at least one year of satisfactory commercial operations and has signed a tripartite agreement (TA) with an IDF-NDFC and the concessioning authority. The TA inturn leverages on any termination payment clause in the project’s concession agreement, to protect the IDF-NBFC from the risk of payment default. The TA ensures that it should receive termination payment within seven months of the first financial default by the project. In addition, the TA allows the IDF-NBFC to initiate termination of the concession if the project defaults, and outlines well-defined timelines for each step of the termination process till receipt of the termination payment. Such a bottle tight agreement in essence enhances the lender’s asset quality and its credit ratings, which inturn allows it to raise low-cost, long-tenure funds from both global and domestic investors, including insurance companies, pension and provident funds that have longer-term investment horizons, consistent with the requirements of the infrastructure sector itself.

So what does all this imply in case of Pakistan? As we know, we have had our own set of serious challenges vis-à-vis growth and CAD (current account deficit). Finding funds for infrastructure development, in order to stir growth and employment, has always been a primary constraint. Meaning, the steps similar to what the Indian economic managers have taken, if implemented here, can bear extremely productive results for us as well. Further, the benefits of developing such funds, which in essence are self-breeding, are far reaching since they help all sectors and are not merely limited to the infrastructure sector. The fixed-rate resources they raise help in: a) Reducing the variability in project cost structures, b) Nurturing cum improving the domestic Bond market quality, c) Maintaining the risk appetite both in the private and public sectors, d) Reducing mismatches in the banks’ asset-liability profile by way of using refinancing through non-banking finance companies (NBFCs) and, last but no least, e) Keeping projects tightly pegged to the agreed time lines. Like India, in order to make this business model more attractive for the sponsors, Pakistan can also provide the necessary regulatory framework incentives such as no-tax status and lower risk weights of 50% for investment in infrastructure projects. IDF, if successfully implemented in Pakistan, can not only help us develop our key infrastructure needs, but more importantly can also help us re-generate our growth momentum that places us back into the line-up of the leading emerging economies of the world.  

The writer is an entrepreneur and economic analyst. Email: kamalmannoo@hotmail.co