A 2012-13 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 5 other countries than in Pakistan. The study identified three key drivers of inter-generational mobility: Family, Labor Market and State. The biggest difference that the family can make is by way of educating and training its children, while a growing labor 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 5 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 neighbor India’s endeavor 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 been doing to change all this? Back in October 2012 they took the following two bold and innovative steps. First, as a policy, they started engaging their trading partners, the ones with whom India runs a trade deficit (primarily China, Japan and South Korea), on agreeing to higher levels of mutual currency swaps and at the same time convincing them to leave their trade surpluses in India (through investment in India’s fast growing infrastructure needs) instead of investing them in US Dollar or western securities. The attraction for these trade surplus countries being that not only does this investment allows them to earn a much higher net return on their surplus capital - than they would otherwise have earned as interest on the USD (US Dollar) - but the option also provides them the diversity they seek in their reserves/investment basket in shifting their dependence away primarily from the USD; thereby reducing the single currency risk.
Second, they have developed a homegrown source for the long-term funds’ requirement in the development of the Indian infrastructure sector: Infrastructure Debt Funds (IDFs). This fund generation is designed to address some of the main issues of this sector by facilitating the flow of low cost long-term funds to the 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 construction projects are usually lower than the threshold expectations of the bond market. IDF-NBFCs will overcome this hurdle by a) lending on infrastructure assets of good quality and b) helping organizations to implement an effective in-house credit enhancement mechanism. Also, in a clear move to encourage transparency and efficiency, and to also maintain an indirect oversight, RBI encourages IDF-NBFCs to invest mainly in the public-private partnership (PPP) infrastructure projects. However, this also only in those PPPs that have completed at least one year of satisfactory commercial operations and at the same time have also signed a tripartite agreement (TA) with the IDF-NDFC and the governmental concessioning authority. Such a TA in-turn leverages on any termination payment clause in the project’s concession agreement in order to protect the IDF-NBFC from the risk of payment default. The TA ensures that in case a default occurs then it receives the 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 benchmarked termination payment. Such a bottle tight agreement in essence enhances the lender’s asset quality and its international credit ratings, which in-turn 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 can Pakistan learn from these initiatives? Ironically, our case here is not too different from that of our neighbor. As we know, we have 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, stands out as our principal constraint. Meaning, that by implementing steps similar to the ones undertaken by the Indian economic managers we can also help go a long way in meeting our capital requirements. Further, the benefits of developing such funds - which in essence are “self-breeding” - are far reaching, since ultimately they end up helping all sectors and do not remain limited to the infrastructure sector. Also, the fixed-rate resources they raise help in: a) Reducing the variability in project cost structures, b) Nurturing 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 not the least, e) Keeping projects tightly pegged to the agreed timelines.
Like India, in order to make this business model more attractive for the sponsors, Pakistan should also provide the necessary regulatory framework incentives such as no-tax status and lower risk weights of up to 50% for endeavoring to 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 to regenerate our growth momentum and place us right back into the line-up of leading emerging economies of the world.

 The writer is an entrepreneur and economic analyst.

Email:kamal.monnoo@gmail.com