Overview 1
1 OVERVIEW
Sebastian Morris
Having dealt with industry structure and regulation, and
governance issues related to infrastructure in earlier reports,
we concentrate on the issue of government expenditure on
infrastructure in this report. The government’s presence in
the infrastructure sector is overwhelming and it would
continue to play an important role. The government spends
large sums of money on the infrastructure sector and yet
the public, in general, is not sufficiently aware of the nature
of this spending.
In this report, the emphasis is on how central, state, and
local governments decide on the expenditure on infrastructure
projects within their jurisdiction and what happens thereafter.
While budget-making at all the three levels of the government
plays an important role on infrastructure spending, a number
of chapters in this report suggest that after the expenditure
is budgeted there is little or no follow-up on the actual
spending and its outcome.
The Comptroller and Auditor General (CAG) which is
the statutory watchdog of government expenditure, and
more recently, the Expenditure Commission, have made
many observations related to government expenditure but
there has been no effective monitoring of expenditure. This
year, our purpose is to identify the shortcomings in
government expenditure in the infrastructure sector. Implicit
in our critique of the expen-diture process are possible
approaches for improvement.
Undeniably, poor governance is the major cause both
for our society not being able to take the reforms process
further, and for our inability to ensure the widest possible
benefits from the reforms that have been implemented.
Nevertheless, we had argued that it is useful to understand
the failure of governance itself to be in a large measure
the result of inappropriate policies and the limitations
therein, the lack of substantial success on the economic
front, and the dysfunctional methods of control, regulation,
and oversight, chosen by the government1. Dysfunctional
politics has been blamed too often for all the ills of
society. It is no doubt an important reason, but blaming
politicians does not help. Points of action to improve
governance and the working of the system lie in policy,
in the legal framework, in reforming the conduct of
election, in administration, and in the regulation of
economic activity. These offer many ‘leverage points for
change’.
Broader Approach
An important aspect of the change is to bring about public
expenditure accountability especially in the provision of
economic services by the state, and in the transfers and
subsidies that the state makes to citizens and other areas
of the state. Here, too policy and legal changes would be
necessary to ensure accountability2. IIR 2003 focuses
1 In a more diagnostic and historical sense, we see the
dysfunctional politics in India itself has been the result of the large
spaces for leakages, rents, and the non-compliance of rules and
regulations, due to the poor design of policy and in the choice of
instruments of control. The two have interacted together to create
an economy of vast rents and directly unproductive activities’.
(Morris, 2002).
2 We had highlighted the role of the right modes for subsidization.
For example, direct rather than price-based susbsidies, non-
discretionary controls, light and incentive regulation rather than
heavy and cost plus, the right to information law that is serious
about disclosure to citizens, the movement away from a cadre-based
administration, a more economic and equitable land acquisition act,
land-use rules and regulations that are non-distortionary and equitable
and more market-oriented, better settlement processes in courts,
use of the right instruments in the control of externalities, are
2 India Infrastructure Report 2003
more narrowly on expenditure accountability in so far as
it is influenced by factors that emanate from within the
system—the process of budgeting, including the allocation
and authorization of resources, audit of expenditures,
incentives for expenditure control and budgeting, the
relationship between the bureaucracy and the executive to
the extent it affects the expenditure process and generally3
the structure and processes of decision-making.
Expenditure reviews will consider the nature and type
of the expenditures themselves, especially in the Indian
situation, where there are the pulls and pressures for
government expenditures to favour particular groups.
Similarly, because the state is democratically constituted
and yet ruled by a thin elite, it not only has the task of
being fair, but of ‘exhibiting its fairness’. When the former
is vitiated because those without endowments are not able
to bring their voice forcefully to the economic processes
of the state, then the latter task of ‘putting on an appearance
of being fair’ can take the upper hand. Significant parts
of social sector expenditures or subsidies meant for the
poor have this role of ‘whitewashing’ the inegalitarian
aspects of the state and its policies. The leakages from such
expenditures and the interception of portions of these
expenditures by functionaries of the state and others,
through bribery and diversion could be quite considerable.
Sub-national Governments
Governance in India is at three levels, though the local-
level governments (that is, village panchayats and urban
bodies) have incomparably smaller budgets on a per head
basis. The centre also has a somewhat smaller budget on
a per head basis as compared to the states. But its large
absolute size and the fact that its policies and budgetary
processes and its fiscal deficit have a major influence on
the state budgets imply that we cover all the levels of
government, bringing out the interrelationships between
them.
We highlight here only those aspects that are not common
in the discussions on public finance in the country. We
are particularly concerned with the incentives (including
perverse) in both intergovernmental fiscal relations, and in
the processes within governments, for expenditure
accountability. This area has not been much explored in
crucial to make the government work for its people. They make the
tasks for both governments and regulators better defined, tangible,
and meaningful. (see 3i Network, 2002)
3 Thus, we take a somewhat broader view than the approaches
of the various public expenditure reviews initiated at the instance
of the World Bank (WB), the Asian Development Bank (ADB), the
Department for International Development (DFID), etc., or of the
Expenditure Review Commission of the Government of India.
the public finance literature in India. The bulk of the work,
thus far, has been on expenditure patterns and proportions
and growth over time and on transfers, and methods or
basis of devolution. The incentive alignment (or its lack)
in budgetary and expenditure processes remains to be
seriously addressed. The work equivalent to the distortionary
effects of the tax system in India that informed the tax
reform in the first half of the 1990s (to usher in value
added taxes and possibly uniform taxes across states in the
near future), is yet to happen with regard to public
expenditures. A significant part of the discussions in this
report, even though our focus has been on the expenditure
related to infrastructure, provides some beginnings to
these effort.
Bringing about expenditure accountability, is not easy
when the initiatives are entirely internal. Thus, we see
internal attempts at improving the budgetary processes,
making it more transparent by systematic presentation4 of
relevant information, is necessary but not sufficient. What
pressures and influences on the government system would
allow it to move in that direction?
Pressures for Change
It appears that the reforms process without any other
initiative or pressure, is in danger of being deflected or
ritualized. Earlier efforts were neutralized or lost in the
weight of the extant processes and approaches to public
expenditure5. But today the prospect of change is bright
since the external pressures on governments and parastatals
to manage their resources efficiently is high. It is not just
the pressures exerted by the World Bank and the ADB,
as part of the conditionality for ‘structural adjustment’
lending, that are important. The current fiscal situation is
unsustainable especially at the state government level6.
Serious efforts to set expenditure processes right are,
therefore, likely. Already certain states—notably Andhra
Pradesh and Orissa—have taken precautionary steps in
anticipation of the problems.
4 Broadly, these include measures such as revealing the structure
and framework of the budget, improving and computerizing
accounting systems, bringing off-budget items on to the budgets,
consolidation of government with the account of vehicles created
for the purpose of public borrowings, developing long-term
expenditure frameworks, forecasting expenditure and revenues, and
removing distortions and perverse incentives to waste and over-
budget.
5 The performance budgets of the 1970s and 1980s did not
amount too much. The Programme Evaluation Studies, the Flash
Reports of the Ministry of Programme Implementation, were
completely ritualized to a point of being irrelevant. Efforts in the
late 1980s and 1990s to set the accounting systems of a few
municipal corporations in Gujarat right, did not yield much either.
6 Defaults on state guranteed loans are increasing day-by-day.
 Overview 3

Privatization the ordinance on loan recoveries8 to help financial inter-

mediaries. That ordinance will allow asset reconstruction
More significant pressures to manage expenditures
and recovery. Banks and financial institutions (FI) badly
effectively will come as the state-owned sector is privatized.
suffered due to delayed and lax settlement procedures with
If state-owned enterprises (SOEs) are privatized, revenue
regard to debt recovery in the country. The danger of the
expenditure reduces automatically through reduction in
cascading collapse of these intermediaries as their non-
labour force and reduction in funding losses. Privatization
performing assets (NPA) levels remain high, made this
has gained a certain degree of acceptance with the successes
ordinance inevitable.
in telecom, ports, and manufacturing sectors. In public
IIR 2003 presents the alternatives adopted by the
services too, the fiscally tight situation can act to bring
government and reviews briefly, the experience of the UK
private–public partnerships especially in areas of urban
in PFIs. As the state is rolled back, we expect the remaining
infrastructure. Successes in areas such as solid waste
accountability to improve, since it would operate in its
management (where the state’s performance has been
domain of comparative advantage. Such roll back of the
abysmal) can create a major opinion in favour of greater
state need not involve any decline in the provision of public
private sector involvement. Such instances are eagerly
services, but can in fact considerably enhance it when
awaited.
wisely pursued. The expected improvement in the fiscal
situation would in turn lead to the selection and
PFIs as an Option
reinforcement of better accountable processes. Other non-
Private Finance Initiatives (PFIs) will occur if the economic factors such as pressures from citizens supported
overarching legislations and frameworks that many state by their right to information that is political and other
governments have undertaken7 recognize its potential. These forces unleashed by the 73rd and 74th Constitutional
would improve the situation by taking out of the public Amendments9, would also contribute to the process of
ambit, major activities and hence, expenditures and bringing change.
them into the private sector through appropriate frameworks
that include regulation. This has happened in a major way Changes in Expenditure Process
only in telecom. Besides irrigation water and the railways,
As privatization and public-private partnerships (PPPs)
which are still largely public, most other areas have been
(with and without PFIs) gather momentum, the project
opened to the private sector. Yet, these have not been able
investments (largely capital formation related) would shift
to take off, except in telecom and to a lesser extent in ports
to the private sector and savings in terms of avoided delays
and now parts of the national highway system. This requires
and cost overruns typical in the public sector would be
further developments in policy and regulation and clarity
possible. But it would take much longer for a significant
in subsidy administration. The continued entanglement of
change to happen in the programmes of the Planning
subsidies with the production process and pricing has
Commission and central and state ministries. The vast
created a mutually reinforcing bind.
leakages and waste could, therefore, continue for some
In the provision of public goods, and where excludability
time. A comprehensive review is long overdue. Objective
is a problem (public health care, city roads, sewerage and
performance measures for these programmes, preferably
sanitation, city cleaning and solid waste), the challenge of
output-based, by exposing their vast leakages, hidden and
developing the right blueprints to bring about PFIs is
heavy administrative overload and failure-prone nature,
greater. The PFI approach of the UK is a good starting
would reveal far better ways of achieving the same
point; but it would have to be contextualized to take root
targets.
in a manner that is functional and in the public interest.
The fiscal crunch has driven reforms, and is likely to
The immediate task ahead in this direction is, of course,
give a push for expenditure accountability, too. The vast
improvements in contract adherence in the country and
benefits from better accountability and shifting expenditures
appropriate legal changes that would help the process.
When pressures emerge, change, which has been elusive, 8 See Section 7.3 for a discussion on the Securitization and
suddenly gets going. This is best illustrated by the case of
Reconstruction of Financial Assets and the Enforcement of Security
Interest Ordinance, 2002.
9 Upadhyay (2002), describes how a national-level assembly of
7 These include the legislations/initiatives the Gujarat
panchayat leaders (sarpanchs) decided to tell the government that
Infrastructure Development Board (GIDB), the Andhra Pradesh the current system of administration and decentralization would not
Infrastructure Initiative Funds (APIIF); the I-DECK in Karnataka, do. And they vehemently asked for real power and resources,
the Tamil Nadu Urban Development Fund (TNUDF), and similar warning the government that ‘paper decentralization’ would not do
organizations in other states. any more!
4 India Infrastructure Report 2003
from the public to the private sectors ought to be an equally
powerful force.
Linkage with Demand
The full potential cannot be realized unless expenditures
(preferably private and capital) rise sufficiently to keep up
the requisite demand pressure and raise investment levels.
The task of reducing the fiscal deficit has, unfortunately,
been pursued without reference to either its macroeconomic
or structural consistency. We have reached a situation
where further reductions in capital expenditure (excluding,
interest expenditure) would keep national income on a
lower growth path through the slow down in demand. Such
reductions have to necessarily be accompanied by structural
change that raises the share of the private sector in
expenditures especially investment, that is, through large-
scale privatizations. Without such a linkage the depressionary
demand overhang on the economy would continue and
deepen10.
The task of bringing about expenditure accountability
in the broad sense is, therefore, challenging but can result
in higher growth and better accessible and accountable
provision of public services. The government cannot escape
those excluded, or those with little access to public services.
Substitution of performance with sloganeering and symbolic
appeal would then be out of question.
The Need for Systemic Change
Goyal in Section 2.2 goes beyond the modern political
economy and public choice literature to argue that the
process of change and development and state action need
not necessarily be a zero-sum game. The gains made by
groups pushing for change need not always arise out of
transfers from others. Change, when wisely crafted, creates
additional resources out of the coordination scale and
other hidden economies, which can be used to push
forward the change. That important insight is brought out
though a journey into the theoretical and conceptual work
in the area, and the experience of China and the US in
bringing about growth-enhancing change.
Goyal highlights, ‘Politics has two basic functions. It can
solve the collective action problem and coordinate to a
better outcome, but it can also use conflict among groups
to maintain power. India has seen too much of the latter
function. Conflicts make democracy slow moving under
inequality and low growth, therefore changes that improve
outcomes for all, and not only for specific groups, are
10 Additionally, the scope for both tax and non-tax revenue
through rationalization of user charges is large. However, this does
not mean that the share of public expenditures should not decline.
required…Changes will occur, but with conscious design
they can be made surer and faster.’ This major conclusion
is really the starting point of IIR 2003. There is much
optimism in the conclusion because it gives us the agenda
and makes the change appear very probable by taking it
out of the control of particular lobbies and groups that
currently seem to stand in the way.
Sooner the value of systemic change is realized, the
quicker it will be to encourage policy-level positions within
the government. Goyal adds, ‘It is often said that a few
good principled people can make a difference: but good
systems can induce better behaviour from most people.’
Systemic change and management of critical institutions
of regulation demand ideas, innovations, and skills from
outside the system. That makes the contestability of all
senior government positions eminently desirable in this era
of crafting and pushing for change.
EXPENDITURES AND PROCESS
Centre and States
Since a significant part of the states’ revenues are transfers
from the centre, either constitutional or through the Plan,
the centre has the key responsibility in expenditure and
deficit management. Thus, early on, it was widely recognized
that if the fiscal deficit of the non-financial public sector
as a whole had to reach sustainable levels, then the centre
would have to run a primary surplus. Such a situation has
not yet been reached. Initially, the centre’s adjustment was
in part done by squeezing the grants to the states. Later
the burden on the states rose on account of both the
implementation of the Fifth Pay Commission Award
(FPCA), and the rise in interest rates. Today, there is no
escape for the states. They have to adjust.
Sen’s review of the fiscal position of the states in Section
4.1 brings out the following salient features:
1. All states are under fiscal stress, though the extent
varies. This has resulted in the compression of capital
expenditures, and expenditures that are crucial for their
provision of public services. Hence, reprioritization of
expenditures is necessary in all states without exception.
2. Roughly 40 per cent of the state’s expenditures were
covered by their own revenues though the figure varies,
and central loans and small savings accounts for most of
the rest. The debt trap of the states is built into their
dependence on the high cost of loans. They could have
gone to the market but without the required discipline,
sufficient revenue surpluses, and the lack of transparency
in both accounting and budgetary processes, the markets
too would impose punishing interest rates.

3. Drawing upon Provident Funds, postponing pension
payments and delaying salaries are the methods used by
state governments to ‘manage’ their fiscal situation in the
short term. Such methods damage the reputation of the
state and their ability to raise funds. They also indirectly
put pressure for change, perhaps even radical change, in
the approach to public expenditure.
4. Off-budget items such as borrowings through public
enterprises and massive increases in payment arrears to
central corporations have gone on, and the limits for both
contingent liabilities and implicit borrowings from central
corporations are being breached. There is little leeway in
this direction.
5. On the revenue side the shared taxes from the
centre increased as the centre went through tax reform.
This initiated the idea of pooling of all taxes and then
carving shares from the pooled taxes. This resulted in taxes
exhibiting a bouyancy.
Dysfunctionalities of Plan Expenditures
The tendency to go in for large plan budgets, along with
the factors such as FPCA and rise in interest payments,
was responsible for fiscal imbalances. Perverse incentives
stood in the way of prudent fiscal behaviour. Sen says,
‘Most important among them is the gap-filling approach
that provides grants to states linked to the deficits estimated
for the award period, projected on the basis of the actual
receipts and expenditures in the base year’! Budgets,
therefore, continue to be soft; there is little moral authority
of the central government to curtail imprudent borrowing
and misuse of overdraft facility with the Reserve Bank of
India (RBI). Public write-off of loans of the central
government have not been uncommon and these have
sometimes been mandated by the Finance Commissions!
And, most important, is the lack of any connection between
the terms of lending and the creditworthiness of the states.
There is an urgent need to rework the annual plans. ‘It
is mainly due to the overambitious plans that both Plan
and non-Plan expenditures have risen fast.11 Unless the
tendency of the political decision-makers to flaunt large
plans as their achievement is curbed, it will be difficult
to curb the growth of expenditures.’
Sen’s analyses as well as the well known waste and
leakages in most of the programmes of the Planning
Commission, and the huge delays and cost overruns in the
11 See Section 2.2 The symbolic aspect of a large Plan budget,
which projects the government of the day as developmental, is one
of motivation. Another is the leverage that is there in the ‘matching
grants’ that underlie many schemes. The vast scope that under-
planning of both capital and programme expenditures offer in terms
of rents, is another factor.
Overview 5
public sector (Morris, Section 5.1) should legitimately lead
us to question planning in India. With the intersectoral
consistency model having been given up long ago, and a
firm commitment to privatization having come about,
there is little reason for national-level planning to allocate
a large part of the central government’s resources. The
traditionalist would claim that better allocation and
evaluatory processes are possible, and so also better design
of programmes and their contextualization. But if these
could have happened, then why is it that after more than
thirty years of planning they have not? Very rarely have
expenditure processes been set right without a significant
squeeze on them.
Recasting the Planning Commission?
In any case departments are involved in a major way in
the Plan so that the Commission’s role can be scaled down.
Its role could be restricted to that of a bureau to the
Finance Ministry to first vet and evaluate expenditure
demands from various departments. The bulk of the funds
now routed through the Planning Commission could go
directly to the states on the lines of the devolution of tax
revenues but with a strong performance linkage. It makes
sense to wind down all central departments whose tasks/
areas lie in the state list, leaving only small cores for policy
initiatives, standards, and data acquisition. The funds so
released from the current programmes and schemes can
be directly transferred to the states, conditional on
performance.
The immediate task is a comprehensive review of the
Planning Commission as an institution, and the expenditure
process for a large part of the centres’ resources (currently
the central plan expenditures and the central contribution
to the states’ plans). Such review should be unconstrained
by the pioneering role that the Planning Commission
played in the past. Public sector GDP shares have been
declining since the late 1980s, and the share of the public
sector in gross capital formation has dipped to less than
30 per cent from its level of 45 to 50 per cent during the
first half of the 1980s. Privatization of the bulk of the
central PSUs is being considered, and the state-level public
enterprises (SLPEs) are expected to follow suit. Therefore,
it stands to reason that the Planning Commisson in its
current format has little role to play. Rather than let it be
caught in a vestigial space from which it creates major
distortions in the expenditure process, as it would in an
increasingly market-driven economy, it is high time that
its role is completely recast.
In this report we could not even pose the principal
dimensions of the problems caused by the incongruity of
a Planning Commission from the previous era. But glimpses
of this are evident in Sen’s identification of the root of the
6 India Infrastructure Report 2003
fiscal problem of the states which lies in the overambitious
plans. Mitra and Pillai identify budgeting for the Plan ‘the
real systemic problem lies deeper in the perceived need to
show a rising Plan budget… and similarly in the practice
of incremental budgeting for the non-Plan expenditures.’
The dual budgeting for the Plan and non-Plan expenditures
creates a major dysfunctionality principally by initiating the
desired link between the two. Plan expenditures also mean
central contributions, so that states are tempted to take on
expenditures (that later become non-Plan) because when
they are Plan, the central contributions are significant. This
‘fiscal trap’ situation is not without its risks when the economic
functionality of the Plan expenditures are dubious unlike
when they were derived out of the intersectoral consistency
model, way back during the Second and Third Plans.
Dysfunctional Budgetary Processes
Mitra and Pillai bring out further dysfunctionalities in the
process of budgeting at the level of the state government
based on their detailed case studies of the process. These
are:
1. Unrealistically optimistic revenue forecasting, since
large expenditures must be justified, especially Plan
expenditures.
2. Incremental budgeting, rather than budgeting based
on a realistic assessment of the requirements and merits
which results in upward pressure on expenditures.
3. The ‘dual budgeting dysfunctionality’ already referred
to earlier, with little or no coordination between Plan and
non-Plan expenditures so that ‘there is no focus on the
overall sectoral costs’; nor is there any incentive for spending
departments to trade-off between Plan and non-Plan
expenditures.
4. Given the form of a budgeting process rather than
true adherence, supplementary budgets become the norm
to allow expenditure overruns beyond the initial budgets.
Similarly ad hoc cash ‘management’ is common since there
is little predictability to either expenditures or revenues.
5. There are no outcome measures, no medium term
perspective, and no involvement of the stake holders.
6. Other deficiences are accounting weaknesses,
including that of reporting statements, but, most
importantly, of the manual and multiple point data entry
system, which despite generating data makes its use difficult.
7. Project implementation is generally woeful, with
few exceptions.
Centre–State Transfers
Sen, drawing from second-generation theories of fiscal
federalism, finds that there are significant deviations from
what good fiscal practice at the state level ought to be:
1. State governments do not raise a substantial part
of the revenue but depend upon the centre.
2. The disbursals are largely formula-based rather than
ad hoc so that the condition that transfers should not be
discretionary is satisfied. But we have already seen that the
Plan funds create major incentive problems against fiscal
prudence.
3. There is approximate fulfilling of the condition that
the state’s expenditure responsibilities match the delegation
of revenue resources.
4. While state governments have the authority to cut
and manage their costs, this is difficult in reality as the
Pay Commission Award pressures would imply. Since the
same bureaucracy runs through the states and the centre
at the officer levels, costs are hardly under the control of
state governments. Given salary expectations of a certain
proportionality with central government employees, on the
biggest of costs, namely salary and wages, there is really
no freedom. Equally importantly, the cadre-based
bureaucracy also makes for similar administrative styles
and procedures which finally determine other costs.
5. The condition that credibly commits the central
government to not bail out sub-national governments is
violated in India. But world-over, there are hardly any sub-
national entities that have not been bailed out by their
federal governments. The point in India, though, as Sen
notes is the centre’s ad hoc and discriminatory grants and
credit enhancements in tight fiscal situations, that clearly
create perverse incentives against fiscal prudence and major
distortions.
6. Similarly, lenders to state governments in India do
so on guarantees by the state (and implicitly by the centre).
This makes lenders abdicate their monitoring and pressure
exerting roles. They could have done much to put the
brakes on state governments from tumbling headlong into
fiscal imprudence.
Figures but Not Facts
Of maximum concern to the citizens are the capital and
public service related items of expenditure of state
governments. Firm and reliable data on these are
unfortunately not available, not only because of intrinsic
problems in data gathering and compilation, but also
because of perverse incentives to misreport. Ravishankar
and Mathur (Section 6.4) bring out the fact that given the
spending cycle, the expenditures not actually incurred but
budgeted are booked to a ‘suspense account’ so that the
spending budgets do not lapse. This has the effect of
overstating the fiscal deficit. On the other hand, the tendency
to draw from ‘pending bills’ and the Public Accounts works
to under-report the deficit position, as the outstandings on
these have ballooned. Lasting solution would need to change

the incentive structure. Ban on using personal ledger accounts
would not work, since there are other ways of getting
around such limits if the incentive structure for adherence
is perverse.
The upward pressure on expenditures that arises due
to Plan funds from the central government means that any
corrective measure would have to ‘reward good fiscal
performance rather than fiscal profligacy’. Today only a
small and insignificant part of the centre-to-state transfer
is linked to performance. The fact that the fiscal deficits
of the state governments are being overstated needs official
recognition, so that strategies to manage it are more
effective.
The Way Forward
The way forward is, of course, to remove the distortions
that currently exist. This would include the review and
recast of both planning within government, and the
institution of the Planning Commission as outlined earlier.
Additionally, and independently, major improvements in
transparency are possible even within the current
constraints. Thus, consolidation of accounts, presentation
of related information including the details of the ‘adjusting
accounts’, summary presentations of the accounts of select12
parastatals of government, presentation of contingent
liabilities of the government along with the budgets would
be the correct step forward. They would save the purpose
of bringing about widespread recognition of this ‘by-passing’
of the legislature that happens in these adjustments and
methods. (Morris, Section 2.1).
Ajay Pandey (see box in Section 4.1) reviews fiscal
transparency in India in the context of the RBI’s Standing
Committee on International Financial Standards and Codes,
which went into the situation in India, by making a point-
by-point reference to the ‘IMFs’ ‘Code of Good Practices
on Fiscal Transparency’. While on many counts fiscal
transparency is good in India, on many others there is
much that is desirable. Besides, as was brought out in the
preceding paragraphs, since the central budget is a major
media event that covers many discussions on the state of
the Indian economy, transparency here can help greatly.
It can quell the pressures on the part of the executive to
go beyond voted budgets. The format of the budget ought
to be expanded to include the framework of the budget,
the model, and the parameters. And the value of the key
variables and assumptions used to work out the budget,
12 This selection could, for example, be defined in terms of the
proportion of liabilities (funded and non-funded) to the government
out of the total. Thus, if more than 50 per cent are to the
government then the parastatal could be included for consolidation
with the budget of the government, or for necessary presentation
along with the budget.
Overview 7
ought to be shared with the public and legislature (see
Section 2.1 for further details).
PUBLIC PROCUREMENT
Policy Induced Distortions
Public procurement is a major activity of any government,
and the items procured span almost the entire variety of
goods and services in the economy. Yet government
procurement has typically been based on lowest price
tender, with certain mechanisms such as inspection and
certification, to get over the problems of varying
specifications and quality. Pandey (Section 4.2) reviews the
practice of procurement in India using the insights from
the general literature on procurement including public
procurement as the backdrop. Public procurement in a
situation of widespread corruption and graft among officials
is not easy to reform.
The current policy-induced distortions which lead to
market failure in procurement by government, especially
of such items as cloth and articles of daily use, require
to be corrected post-haste. These include the price
preferences for small scale and local units, various clauses
that limit the number and categories of bidders including
unduly specific qualification clauses. State failure (resulting
from multiple and sequential processes in procurement)
brings about market failure as when the procurement
agency selects the poor performers (adverse selection).
These are not uncommon in India. The simple solution
is, of course, to eliminate those long-winded processes and
make procurement decentralized so that authority and
responsibility embedment can take place.
Complexity Needs Recognition
Procurement of complex multi-faceted goods whose
specifications cannot be easily written down, codified, or
verified, would require very different procurement processes
from the procurement of shelf goods. For shelf goods there
is much scope for standardization and rate contracts that
avoid repeated evaluatory processes. There are vast
improvements that can come through appropriate design
of procurement and bidding that is sensitive to the nature
of the good and the experience with regard to the dimensions
of failure. This thesis is developed by Pandey. For
construction contracts and the procurement of public
services independence of the agency or individual making
the quality and quantity verification is a must. Ostensibly
independent agencies within the government like the
Director General of Quality Assurance (DGQA) for the
procurement of ordnance stores have been rendered
dysfunctional. Today, they serve as barriers in the
8 India Infrastructure Report 2003
procurement with clearance being arranged for a price. But
the recent developments initiated by the National Highways
Authority of India (NHAI) where the ‘independent engineer’
who verifies the quality and quantity of National Highway
Development Project (NHDP) construction is carefully
defined and appointed, reduces significantly the possibility
of collusion in the foreseeable future.
Transparency is the Key
Transparency and disclosure are prerequisites for making
the bureaucracy accountable. Oversight by the end users
(public), stronger deterrents, and ensuring the independence
of various authorities from government are also necessary
prerequisites Pandey says ‘While transparency and
disclosures are necessary for monitoring, they are no
substitutes for public awareness and consumer activism in
curbing the perverse incentives of the public officials.
While all this sounds ambitious, the least that can be done
by the policy analysts is to factor in the poor outcomes
of public procurement processes in new initiatives such
as privatization and PFI.’
This excludes the purchases of non-departmental
enterprises, which are likely to be considerable. Thus, the
importance of current procurement for the system’s
efficiency cannot be overstated. As the role of the private
sector increases the relative role of procurement over
generation and production by the state increases13.
The CAG audit of procurement which is post hoc and
procedural can only be a small aspect of the oversight on
procurement.
CAPITAL EXPENDITURES AND COST OVERRUNS
Large Growth and Fiscal Penalty
It may not be wrong to say that the fiscal crisis of the late
1980s and the early 1990s was in a large measure due to
the large delays and cost overruns in public sector projects.
Cost overruns of about 60 per cent and delays of 50–70
per cent from the original scheduled time, were common.
The macroeconomic effect of this on growth of the economy
was considerable. Public capital formation was as much
as 40–50 per cent of GCF in the economy. Therefore, we
can estimate that the economy grew slower by between 1.5
and 2.0 per cent than what it would have otherwise grown,
given the same savings rate and the output capital ratio
in the economy. This is an underestimate of the growth
13 PFI is also a special form of procurement of public services
that is acutely concerned with getting the contract right. It attempts
to allocate business risks on to the private sector and bring about
private investment in public services for payments from the
government and/or charges leviable on users.
penalty suffered on account of public capital formation
since there were other leakages such as rents and kickbacks
to be reckoned with. (Morris, Section 5.1)
Some Improvement
Over the 1990s there has been a perceptible improvement
in public sector project implementation but the delays and
cost overruns still remained high. Despite this, the share
of the public sector in capital formation had come down
to about 30 per cent, while the investment rate as such
showed a small improvement by about 2–3 per cent. So
the overall growth potential of the economy was more than
7 per cent, but because of the monetary and fiscal
conservatism, despite the supply side potential, it was not
achieved due to the demand shortfall that such macro
policy implies. This aspect of reform—that as wasteful
expenditures or rents decline or are eliminated, there is
a need to step up more functional expenditures, especially
private investments so that the expenditure pressures are
kept up—is not often realized in the discussions. Clearly
then, growth and privatization emerge as the only workable
options to reduce the fiscal deficit.14 Boxes 2.1.1 and
2.1.2 discuss this issue at a conceptual level.
Factors underlying delays and cost overruns have changed
somewhat since the mid-1980s. The contract award decision,
land acquisition and environment clearance, etc. are major
causes of delays today, and the financial constraints
(spreading thin the resources) are less important. There
were significant differences sectorally. The eastern region
showed somewhat poorer project implementation. These
differences are brought out in a multivariate analysis.
Railways Capital Budgets
Sriraman (in Section 5.2), brings out the budgeting process
of the Railways, especially with regard to its capital
expenditures. The dysfunctionalities in the Railways,
budgeting are many. Most remarkable is the arbitrary (and
varying) depreciation charge. Moreover, the depreciation
charge currently at 2.6 per cent per annum is too low to
result in any kind of self-sufficiency in investment funds
for maintenance and asset replacement. Given the many
funds for capital expenses, and their defined purposes and
relationships, even the (small) available depreciation funds
get diverted for non-remunerative projects. The problems
specifically noted are:
1. Undertaking many more projects than what is viable,
and the resulting underfunding, which inevitably brings
about vast delays and cost overruns.
14 The other choice always available is, of course, to inflate the
fiscal deficit away.

2. A near complete politicization of the projects in the
garb of the social necessity of projects, essentially to
pander to the constituency interest of the Railway ministers
of the day.
3. Huge expenditures in dubious (or non-priority
projects) such as gauge conversion.
ERC REPORTS
Varkkey in Section 5.3 reviews the Expenditure Review
Commission (ERC) Report on the Ministry of Urban
Development and Poverty Alleviation. He brings out the
strange category of ‘decision taken but not implemented’,
(such as elimination of a post and an item of expenditure
no longer needed) which is rife in the ministry. This
forcefully brings out one of the major problems of
governments in India—the inability or difficulty to shed
activities and staff no longer required. Even ‘decisions
taken’ over ten years ago to abolish certain posts, were not
implemented. The Department of Supply is intimately
connected with procurement by the government and the
ERC goes into the working and structure of the department
to downsize it.
Some of the key factors in the dysfunctionalities of the
Ministry are:
1. the diversity of activities and a significant part of
the portfolio of activities being vestigial in nature.
2. Overlapping jurisdiction as between the ministry,
the New Delhi Municipal Council (NDMC), and Land
and Development Office (L&DO).
3. Obsolete work norms and productivity levels of the
order of 10 per cent of these norms.
4. Large numbers of surplus employees.
4. Little or no use of IT.
5. Rent generation possibilities in contracting out in
certain dispute settlement processes over procurement.
Vast improvements as mentioned by the ERC are possible
with privatization, contracting, rationalizing and
implementing previous decisions, to considerably reduce
the activities of the ministry. This report of the ERC (being
somewhat more expansive than others) allowed Varkkey to
present a picture of the large slack and waste in the normal
day-to-day working of typical government departments.
Pandey (box of Section 4.1) reviews the ERC report on
the Department of Supply and highlights some of the
findings that Varkkey brought out with regard to the
Ministry of Urban Development and Poverty Alleviation.
Much diversity of tasks, sections and posts ‘decided’ to be
abolished were not implemented, much waste, overmanning,
and the existence of vestigial facilities continues.
Overview 9
SOCIAL EXPENDITURES
The Planning Commission’s role as an allocator and the
pulls and pressures that act upon the Planning
Commission, and also the ‘tussle’ with the Finance
Ministry are brought out by Mahendra Dev (Section
6.3). Increasingly career civil servants find postings in
the Planning Commission and the role of outside experts
has declined. But postings to the Planning Commission
are sometimes even considered as ‘punishment’ postings.
The Commission’s eminence has been eroded considerably
as a result.
Political Determinants
The processes of the Finance Ministry in formulating the
budgets are not sufficiently consultative, while those that
lead to the Plans are, as the numerous working groups
and sub-groups of the Commission indicate. Fresh agenda
such as concern for women, children, and the environment
are brought into the Planning Commission inter alia
through these consultations. As on Plan expenditures, but
even more so, there is usually much bargaining between
the Planning Commission and the Finance Ministry.
Finally, the level of social expenditures is determined by
bargaining and the political situation, the general belief
(shared by Mahendra Dev) being that ‘social expenditures’
would win votes. But perhaps the real reason, in our view,
is that the politician wants social expenditures, especially
when they take the form of leakage-prone targeted
programmes, because of the opportunity for patronage
they provide. (see Goyal, Section 2.2, and Morris, Section
2.1). The ‘contractor raj’ is an important pressure group
working towards capital expenditures in the Planning
Commission and elsewhere in the government, and
would have a counteracting influence since in pushing
for construction projects the neglect of much valued
social expenditures such as education and health can
occur.
Trends and Patterns
In Section 6.2 Mahendra Dev reviews the trends and
patterns in social sector expenditures over time, sectors,
and states. Expenditures have not shown the promised rise
since reforms began. They have fallen marginally in the
1990s as compared to the 1980s in relation to GDP, and
similarly, risen somewhat in relation to aggregate expenditure
of the government. Capital social expenditures have shown
a relative decline. There are wide disparities in the per
capita social expenditures between the states, but these are
largely reflections of the differences in the per capita
incomes between them.
10 India Infrastructure Report 2003
THE IDEA OF PRIVATE FINANCE
George (Section 7.2) brings out the principal characteristics
of PFIs, providing an introduction to the law that underlies
PFIs in India. She also looks at the NHAI Act and the
recent initiative of the NHAI to use annuities to build
segments of the national highways as PFIs.
Contextualization
It is important to bring private finance into infrastructure
in India despite the major difficulties that stand in the way.
In our society the economic rules, settlement procedures,
and governance structures have led to abysmally poor
contract adherence on part of many entities including the
state in several important dimensions. Hence, the very
idea of a long-term contract with the state is adjudged
risky. Markets, not trusting the contract adherence, would
impose high costs on such finance and, hence, PFI ceterius
paribus is likely to be a high-cost option. Overcoming the
difficulties that stand in the way of contract adherence is
necessary not only for the success of PFIs, but also to
ensure economic development. PFIs do not really demand
additional conditions over those required for the success
of sustained public service provision even by the state15.
But PFIs can lead to vast gains, due to the natural and
easier incentive alignment or compatibility that they bring
in areas of public services by bringing private management
in with private finance.
Much Potential ...
As Varma (Section 7.1) makes it amply clear, PFIs are
an instrument to combine private finance with private
management. The seeming option to combine cheaper
public money with private management in the ‘vanilla’
PPPs much in vogue, is actually problematic since they
demand a difficult craftsmanship in the design of contracts.
Even very good contracts prove to be incomplete as the
reality unfolds. This is so because the future always
encompasses fundamental uncertainty which is difficult
to anticipate. When private money is at risk, there is
greater possibility of incentive alignment without the
need to design complex contracts whose value in
unexpected situations is dubious. In India, PFIs have an
additional advantage, and needs—networks are built,
coverage of public services increase, and the potential
growth of the service network is high. Hence, demand
15There are large dues pending to the NTPC and other central
power corporations, coal companies, wholesale water companies
(jal-nigams).The delays in payment of salaries and pensions. Today,
water and power are major sectors constrained by lack of contract
adherence between the state and its arms and parastatals.
side risks which the state may be asked to bear in the
most public of services is much less, especially if the
society is willing to live with some shortages at the
margin.
The government usually bears the demand risks in areas
such as health services, real estate services for use by the
government hospitals and prisons office. These services
are normally thought of as being in the public sector. The
same holds true even in sectors such as roads, bridges and
pipelines, though here the best option is really to pass on
much of the risks to the private sector through appropriate
structuring and design.
...but Dangers, too
Many PFIs are sophisticated methods of off-budget
financing of at least some projects. However, this should
not deter us from the potentially large gains that the
approach makes possible. Good accounting processes,
and transparency in all dealings and the avoidance of
‘enronic accounting’ are necessary to shift risks on to
markets, which are eminently suited to bear them. PFIs
make it imperative that the state adheres to its contracts.
Contract enforcement against the state is a fundamental
problem of businesses and not new to PFIs, but here the
problem is explicitly revealed and is particularly acute.
When debt financing of PFIs goes through markets,
markets building on the worry of the states to guard their
reputation in the market have a better chance of enforcing
contracts against the states than even the biggest individual
firms. This is another reason for the importance of private
finance in PFIs.
Not Comparisons but Risk Transfer
Barua and Gujarathi (Section 7.4) continue the discussion
on the experience of PFIs in the UK and review much of
the critical literature. They bring out the basic problem
in the idea of a public sector comparator, though appealing,
is difficult to implement and operationalize. Often the
relevant comparator is non-existent, or the problem is akin
to comparing apples with oranges. The actual risk transfer
on to the private sector has been much less than is often
claimed. And careful ex-post scrutiny reveals that the
benefits of PFIs have been exaggerated in many cases.
More importantly, they highlight the accounting challenges
to successfully take PFIs through. As also pointed out by
Varma, the principal challenge lies in bringing about
transparency. Hence, accounting and reporting become
important both from the point of view of market valuation
and from the government’s own public finance viewpoint
so that critical levels of exposure and borrowings are not
exceeded.

The UK initiatives do provide for the ‘Local Government
(Contracts) Act’ to empower sub-national governments for
PFIs. It also guards against illegality of contract risk which
may be necessary when PFIs are beginning and still
experimental. Partnership UK, a joint-venture between the
government and private firms and developers interested in
infrastructure development, had a crucial role in popularizing
and initiating PFIs. Similar, but perhaps more appropriately
structured, organizations to reflect the interests of the final
beneficiaries of the public services are required in any
economy, especially a transforming one attempting to push
PFIs in a major way.
Ensuring Risk Transfer
In the UK, regulatory developments that necessarily link
at least 20 per cent of the cash flows to the private party
to depend upon measures of performance and the usage
of assets were found necessary to ensure significant transfer
of risk to the private sector and markets. The accounting
methods and standards that have evolved with regard to
PFIs allow particular projects to be classified as defacto
borrowings or otherwise, based inter alia on the degree
of risk borne by the operator. The review brings out the
sensitivity of the comparator analyses to the discount rate
and the value added tax (VAT) rate exemption on the PFIs.
The critical reviews underlie the need for more information
especially on the extent of non-cancellable payments. Else,
there is a danger of jumping headlong into PFIs without
the clarifying developments, accounting initiatives, and
improvements in the legal framework. This would destroy
a good and important way to take the economy forward.
Yet the fiscal crunch and the need to expand the provision
of services make it imperative that the initiative begins in
all earnestness.
Unlocking the Potential
The task ahead is to take PFI forward and make it an
important mode for the provision of public services. The
UK had to invest much effort and expenditure in designing
PFIs and in training civil servants to create the correct
frameworks and design of particular PFIs. Interestingly a
large part of the development and understanding now
available in the UK could carry over to the situation of
extensive use of PFIs elsewhere. Nevertheless, it is necessary
to bring contextualization to the situation.
There are vast spillover benefits in the pursuit of the
correct PFIs. Accounting and legal reforms, developments
in transparency and in regulation of financial markets,
enhancing the capacity of governments, and better
definition and measurement of outputs, need to occur
along with PFIs. All these can, when PFIs are honestly
Overview 11
pursued, lead directly and indirectly to better public
expenditure accountability. Reducing the fiscal deficit in
India today, as we have said before, has come up against
the structural constraint of the government’s large role in
investments. PFIs and private investments in general need
to take off to raise the growth rate of investments so that
adequate expenditure pressure is maintained to ensure
high growth.
Better Contract Adherence
PFIs or not, the costs of transacting business in India has
been very high due inter alia to the dilatory settlement
processes, especially dispute settlement. More specifically
where courts are involved settlement takes much time.
Given the vast delays in courts, gaming the courts to
dodge adherence or reduce the private costs of non-
adherence is rife in the society. The ex-post difficulties
when disputes arise result in very large risks being perceived
ex-ante and certain kinds of deals and activities whose
outcomes are difficult to anticipate. As a result many
important markets function inefficiently or may not even
exist16. This problem is acute for financial intermediaries
seeking recovery of dues made out to firms and projects.
NPAs have been large and recoveries of NPAs have been
very slow and long drawn out affairs. Institutional
arrangements like the BIFR Act actually compounded the
problem. The cleaning up of the banks and former
Development Finance Institutions (DFIs) started with the
shoring up of their capital base to meet the Basle norms.
But the deeper problem was the weak recovery process
in the country. The ‘Securitization and Reconstruction of
Financial Assets and Enforcement of Security Interest
Ordinance 2002’ seeks to correct that problem by vesting
vast powers with the FIs, banks and others seeking
settlement of their dues.
The Ordinance
Although a development in the financial sector, the
Ordinance (once certain inconsistencies and difficulties
are ironed out) has the potential to greatly reduce risks
in lending and hence to considerably lower the spread in
the activities of banks and FIs in the long run, even if
immediately perceived as an overly powerful tool in the
hands of the financial intermediaries. An efficient and
developed financial sector is of particular interest to
infrastructure financing, especially when deep lending is
important.
16Besides credit markets which are so affected, land and real estate
markets are badly affected by little protection against land grabbing,
and by unreasonable rights of the tenants enshrined in the law!
12 India Infrastructure Report 2003
The Ordinance also provides the basis for securitization,
so that markets can be brought in to bear on loans originally
deployed by institutional initiative. Of course, much
development in terms of appropriate instruments and
standardization would have to take place, before
securitization of such loans made out on housing and real
estate development, and other infrastructure investments
can take place.
Joshi and Anuradha (Section 7.3), bring out the salient
features of the Ordinance. While the ordinance would
clear the ground for the development of securitization, its
ability to improve the enforcement beyond a point is
somewhat doubtful. The author feel, ‘Enforcement processes
[in the Ordinance] can be triggered only after the debt has
become an NPA.’ And in large projects with an eye on
the market valuation of their activities there could be
reluctance to declare NPAs quickly enough. This aspect
does not get recognition in the Ordinance. They take the
case of the Dabhol Power Project now awaiting restructuring
to develop a scheme to recast it as a contract generator
in the light of the provisions of the Ordinance. The NPAs
of the Industrial Development Bank of India (IDBI) and
other FIs could then be turned over with the plant quickly
up and running.
THE LOCAL BODIES
Many Problems
Local bodies, especially urban, have the key role in the
provision of many infrastructure services. This is because
these services, more than other economic activities, have the
spatial aspect which almost completely corresponds to habitats
and their administrative aspect—the municipalities. The
basis of urbanization lies in the large agglomeration economies
in economic activity, especially trade, commerce,
administration, and manufacturing. It cannot be attenuated
or overcome by efforts at rural development as is widely
believed17. But in India the administrative process has
emasculated the urban local bodies (ULBs) and Panchayati
Raj Institutions (PRIs) which are charged with the management
of central places. With the 73rd and 74th CAA, the slow
process of the movement to their rightful roles in the provision
of infrastructure has begun. If PFIs, or for that matter, any
private or public–private initiatives, have to take off the
capability of the local bodies and their financial standing have
to improve considerably.
Though enhanced contributions and transfers and fiscal
devolution have to play an important role in this task, it is
17
Nearly all known development actually leads to urbanization,
though the particular form it takes can differ.
only one of the many dimensions where change is required.
Their fiscal positions can sustainably improve only if user
charges and collections become rational allowing local bodies
to recover a substantial part of the costs of services and bring
about reduction in the wasteful usage on consumption. Their
accounting and reporting systems are inadequate, their
organizational processes are messy with little probability of
responsibility attribution and they face growing uncertainty
with regard to their revenues while they are constitutionally
charged with the provision of a large variety of services. They
are not entirely free either to fix user charges and their poor
fiscal position makes it impossible to go to the capital
markets for funds unless they have access to the guarantees
of their governments. Although transfers from the state and
central governments have gone up, these are possibly not
keeping with the increased demands on them for the provision
of public services. There is an urgent need to improve ULBs’
reporting systems.
Organizational and Administrative Changes
Urban scholars and others looking at PRIs have studied
the fiscal situation and believe the answer lies in larger
fiscal transfers. We believe that increased transfers are
necessary but more importantly the transfers need to be
untied from the Plans and schemes of the central and state
governments and made available for locally decided
expenditures. There is little point in having elected members
and separate constitutional status if there is no discretion
in spending. Such discretion is necessary for responsibility
embedment and for efficient expenditure management.
Their relationship with parastatals has to emerge out of
their own needs and requirements as they assess these on
their own terms in such areas as drinking water, roads and
housing. Funds in these areas have to be routed through
local bodies, rather than to the parastatals as is currently
done. Similarly, the politicization at the local level cannot
reduce unless local leaders in being elected members of
the PRIs and ULBs have the ‘space’ to make political
capital out of initiating and completing projects that provide
public services. The rules governing the relationship between
the elected members and officials have to change. It is
evident that despite the CAAs not much has changed at
the ground level. We have not been able to investigate
deeply into the problems at the local level because the data
is not available. The questions are only beginning to be
asked.
The PRIs
Mathur (Section 9.3) brings together available financial
information on PRIs to show their very large dependence
on the state government. He also reviews the

recommendations of the state finance commissions some
of which have made innovations in allocating resources to
the PRIs and ULBs. Uniformity is lacking but firm
beginnings have been made to transfer resources to the
PRIs. The next step, as we have mentioned, really is to
untie the Plan funds allowing PRIs to define and implement
their own schemes and projects. PRIs would find projects
more useful that aim at public services and related
employment creation.
ULBs of Maharashtra
In the urban context the situational information relating
to the ULBs of Maharashtra are brought out by Pethe,
Karnik and Karmarkar (Section 8.4). In Maharashtra,
significant fiscal devolution has taken place. The patterns
of finances and expenditures of the Mumbai Municipal
Corporation are distinctly different from that of the other
municipal corporations, or the municipal councils in lesser
towns. This is expected since there are significant size and
scale effects in the costs of services. The demand patterns
are also likely to be different. Expenditures of ULBs have
on the whole risen faster than the nominal value of GDP,
so that with the CAA there has been a perceptible change
in the distribution of resources between the various tiers
of government. Changes in the distribution of expenditures
over items have also been significant. These have varied
much across the ULB groups. Salaries and wages have
covered an increasingly large part of the expenditures, so
that despite increases in expenditures and transfers the
effective increases in the provision of urban services may
have been marginal.
BEST AND MMC
Sriraman and Mukhopadhyay (Section 8.3) takes a look
at the budgeting processes in one of India’s best run
municipal corporations—Mumbai. Even in this quick
analysis it is evident that the budgeting processes, the
structure of the board and the organization, and the nature
of the interface with the government are crucial to
performance. The Bombay Suburban Electric Supply and
Transport Undertaking (BEST) because of its professionalism
is able to keep at bay dysfunctional interference that could
have derailed its commercial orientation. But there are
strong pressures. It is no longer financially self-sufficient.
The limits to cross-subsidizing road transport with surpluses
from electricity have been reached, as electricity itself has
become a problematic. As financial independence gets
eroded so would organizational independence and
professionalism.
Overview 13
Accounting Reforms
Joshi (Section 8.1) brings out the interesting case studies
of Tamil Nadu and Karnataka which seriously pursued
municipal accounting reforms. It is crucial to have a
commitment at the top and a the strong-felt need for the
involvement of personnel within the municipal bodies.
Tamil Nadu has made the transition to double entry accounts
that would allow its ULBs to operate better and more
transparently. Karnataka too has pushed hard and would
most probably make the transition. Accounting reforms
are unavoidable. It is surprising that other states have not
followed. As Joshi argues the need for standardization of
municipal accounting across the country is of utmost
urgency. Non-standard developments would increase the
cost of monitoring the functioning of local bodies through
markets and financial intermediaries and would ultimately
restrict their access to markets and raise the cost of their
funding.They would also make citizens’, monitoring more
difficult. The Gujarat experiment of municipal accounting
reforms which failed to take off, and the contrast with
Tamil Nadu which succeeded, point to the ‘power of felt
need and pressures’ in the pursuit of change. In Gujarat
the experiment came a little too early and the (lukewarm)
pressures for change were limited to the multilateral agencies
which were pushing for it. In Tamil Nadu, the state
government and the bureaucracy had internalized the need
for municipal accounting reforms.
Municipal Bonds
Sadhu and Bharatwaj (Section 8.2) bring out the story of
municipal bond floatations. With the market being too
thin, bonds have only been a marginal source of funds for
the ULBs, and that too, at very high cost, despite government
guarantees since the payment risk is quite high. Considerable
all-round improvement in the working of ULBs and in
their financial capacity are necessary before they can
successfully raise money in financial markets at reasonable
costs. They need to be able to generate resources to service
such borrowings. The problem is not so much with the
financial markets, though a certain degree of financial
engineering of the instruments such as pooling and bundling
could have helped. Securitization and open rating of
municipalities rather than of bond issues alone would help
to bring about greater transparency and market
development. Liquidity in the market can be developed
through buy-back arrangements and increase trading levels.
Standard accounting practices, commercial type audits,
ratings and enhanced provision of information are necessary
for the market to develop.
The contrast with the situation in the US is stark. There
municipal bonds are an important component of the
14 India Infrastructure Report 2003
financial market and provide an opportunity for long-term
investments by pension and other funds. The bankruptcy
processes that enable quick settlement of claims, the
professional management of municipalities, responsibility
embedment and significant local generation of resources
make local bodies capable of raising funds in the market
at very low premiums above the rate on risk free assets.
Pooling and securitization are additional features that create
liquidity in the market. The US experience underlies the
urgent need for reforms in India.
RURAL INFRASTRUCTURE
Importance of Irrigation Pricing
Getting irrigation pricing right is perhaps the starting point
for infrastructural pricing reform. Farmers in most parts
of the country with canal irrigation get water at prices that
do not even cover the operations and maintenance (O&M)
costs. The rates for full cost recovery would be far below
the rates at local water markets when these exist, and much
below the marginal product of water. Several irrigation
pricing enquiry committees had recommended convergence
to full cost recovery. The last committee in 1994 headed
by A. Vaidyanathan also made this recommendation, but
went further to suggest ways to bring about the same. Even
electricity reform gets linked to the pricing of canal water.
As we brought out in IIR 2001, the farmer without access
to canal water would demand electricity subsidy to avoid
discrimination. The committee suggested handing over the
management of irrigation networks below the main canals
to farmers and their suitably organized cooperatives. The
costs of O&M in maintenance of distribution networks
can be passed on and they would have automatic incentives
to manage it efficiently. They would also have the advantage
of using low cost methods for maintenance including the
use of self labour and supervision.
Large Implicit Subsidies
That agenda is taken further by Vaidyanathan (Section 9.1)
in the context of the current fiscal crisis. Irrigation accounted
for Rs 14,000 crore of subsidy which is about an eighth
of all subsidies (implicit and explicit) in the economy.
Implicit subsidies were about 12–13 per cent of GDP and
direct subsidies about 2 per cent. Water and irrigation
development had been priced adequately under the British
so that financial sustainability of the irrigation works was
not a problem. Under planning, and later as the ‘redistribution’
agenda emerged at the forefront of state policy during the
stagnation period (1965–79), the state moved away from
cost recovery despite the warnings from several expert
committees. The successive Finance Commissions though
diluted the standards of cost recovery. Vaidyanathan
highlights, ‘Thus the interest charges to be received from
the beneficiaries was lowered from 2.5 per cent of investment
recommended by the Fifth Finance Commission to 1 per
cent by the subsequent two Commissions.’ To move towards
cost recovery ‘fairness also requires that users are charged
on the basis of investments required at reasonable levels of
efficiency. This implies that investments in ongoing projects
which are yet to begin delivery of water must be excluded
in the forming of rates. Vaidyanathan adds that, ‘users must
not be required to bear the cost of overcapitalization due
to over design, poor design, and inefficiencies/leakages in
construction.’ It is necessary to have indexation with the
price level and a convergence profile. Even if the recovery
today is partial, the method must lead to full cost recovery
in old projects over time.
People’s Involvement
Rath (Section 9.2) reports the situation on water users’
associations (WUAs) in Orissa. He brings out the
remarkable success in efficient irrigation management that
came with the introduction of the Pani Panchayats (PPs),
or Water Users’ Associations (WUAs) which managed the
lower distributories and the distribution of water. Farmers
have reported economic and other intangible benefits such
as better access to officials, reduced political and
bureaucratic interference in the working of irrigation
distribution, and, most importantly, a sense of camaraderie
and ownership of the network. PPs have fostered a major
organizational development that has the potential to take
up common property and collective issues without coming
up against the free-rider problem.
But Collections?
Efficiency in water use has gone up significantly. This is
reflected in improved yields, better cropping patterns and
greater availability of water. Wastage from the canals have
reduced by about 80 per cent. A major allocative efficiency
gain has come with the freedom of the farmer to choose
his cropping pattern. While all these gains have been
realized, farmers have resisted paying for the use of water.
The design probably did not build payment and recovery
of user charges integrally into the model. Currently, the
threat of stopping the supply is not credible enough. The
District Magistrate (DM) has little incentive to collect the
water revenues once his revenue target is reached from all
other economic activities. Differential recovery leads to a
sense of unfairness and resistance to pay up. Credible full
collection, even if this means high initial collection costs,
is the feasible solution since the gains to the farmers are
quite obvious.

RIDF and ‘Off-Budget’ Expenditures
The Rural Infrastructure Development Fund (RIDF) is an
‘off-budget’ arrangement to continue to fund the state
governments’ their capital formation activities in the
infrastructure sector. The opportunity came because the
commercial banks, as a whole, could not meet their directed
targets of lending to the agricultural sector. The attempt
was to direct these resources to complete projects which
were near completion but awaiting funds. Hence, the
marginal return to these investments have been very high.
But that does not imply that the scheme as such will
significantly improve project implementation. State
governments have an incentive to pay back since it is like
‘ponzi’ finance. Hence, 100 per cent recovery is not an
indication of the soundness of the scheme. In any case,
financing is entirely guaranteed by the state governments.
Similarly, the high returns at the margin does not indicate
soundness of a scheme. Overall delays and cost overruns
even on the part of the project covered by the RIDF have
been substantial. The claim that a high level committee
monitors the projects does not mean better management
of the projects. Nevertheless, a certain allocative efficiency
may have come into the sanction and disbursal of RIDF
funds, since the very poorly performing states have not got
the funds as projects have to be initiated by the state
government. Albin and Morris (Section 9.4) cover these
issues.
OTHER SECTORS
Correct Designs Do Work
Getting the policy and design right is half-way towards
winning the battle. In a difficult area it is gratifying to
report that NHAI got the NHDP right, and has been able
to put together a scheme with a reasonable incentive
alignment better than anything before. As a result the
national highways, especially the Golden Quadrilateral, has
become a reality. The key to the development was:
1. The imposition of a cess on fuel to finance road
development and its allocation credibly for the purpose.
2. The contract design that makes it necessary for an
‘independent engineer’ to verify the quality and quantity
of the construction.
3. The somewhat better incentives for the contractor
to build the road to the correct specifications.
The bulk of the NHDP is to be awarded on the above
basis. The build, operate, transfer (BOT) contracts on an
annuity basis are more interesting. Here there is a strong
and direct relationship of the payment to the output of the
BOT operator. In both modes the construction and
Overview 15
completion risk is on the contractor. Just as in any other
country, good policy and framework does work in India.
Rastogi in Chapter 3 brings out the developments in
infrastructure sectors over the years.18
Delhi Vidyut Board Privatization
Other developments have been the privatization of the
Delhi Vidyut Board. Here the state’s electricity distribution
has been privatized with a commitment on the part of the
distributor to reduces losses. If the distributor reduce
losses beyond the agreed target, he keeps a certain
proportion of the money so made. This is a powerful
incentive to bring down leakages. Uniform retail tariffs are
a solution to ensure against leakage and provide the correct
information to the regulator. But the problem of having
the reform strategy entirely right for Delhi is less critical
than it is for other states with agricultural load. We have
contended that the only workable solution to the problem
of electricity distribution in states with significant
agricultural load is the complete separation of subsidy from
the commercial management. This is by directly giving the
subsidy to the farmers (Morris, 2001).
Sinha (Section 10.1) reviews the Delhi and Karnataka
privatizations in detail and concludes that the distribution
margin ‘privatization needs to be preceded by a pre-
transition privatization phase, which can used to bring
about risk mitigation’. In his view meaningful privatization
would be possible only with progress in metering, billing
and collection, reduction of cross subsidies, non-interference
in tariff matters, and transfer of the irrigation load to a
separate organization.
VSNL Privatization
Tariffs in telecom have fallen dramatically as competition
and the force of technology have worked. Many of the
more aggressive players are at a point where the consumer
side network economies (of being connected) have begun
to operate. The network would, therefore, grow very
rapidly. But interconnect remains a problem and MTNL,
BSNL and other players, including mobile players, need
to be opened up for interconnect of competitors’ lines,
at rates that are fair and no higher than for own use. The
regulator would have to declare the rules and the rates,
rather than wait for any framework to come from the
government. Jain (Section 10.5 ) traces the events leading
to and following the privatization of VSNL. The role of
the Board in the post-privatized situation is an issue.
18 We do not summarize this chapter here. The reader is advised
to read Chapter 3 for a review of the events in infrastructure during
the year.
16 India Infrastructure Report 2003
While the privatization has possibly been the best under
the circumstances, the possibility remains that ‘public
floatation of the stock might have lead to better values for
VSNL had it been prepared for privatization’. But if quick
privatization was the objective the strategic sale approach
cannot be faulted.
Irrational Tolling
In the case of the Coimbatore by-pass toll road,
inappropriate bundling at a time when BOT meant tolling
as the only source of revenue, caused major problems. The
bundling lead to the inclusion of a much-used bridge well
within the city for tolling. Citizens vehemently opposed toll
collection on the bridge. The problem was compounded
by the lack of flexibility of the operator to alternative
arrangements, and the inability of the state to impose a
contract against the will of the people. The case flags an
important issue—that of tolling limitations. Already truckers
opposed to tolls point to the high share of tolls in their
operating cost.
Solid Waste Management
Varkkey (Section 10.3) discusses the case of a modern
solid waste development project. The case brings out
several hurdles that a project can encounter—urban–
rural or local–city divide, environmental and labour
problems. Additionally the unanticipated use of the garbage
and the payoffs from it to employees of the Trivandrum
Municipal Corporation meant that they stood to lose if
the garbage was treated! Nothing better illustrates the
pitfalls in pursuing a project, even a technically sound
one, if it is not contextualized and the stakeholders are
not involved.
Reforming the Railways
Raghuram (Section 10.4) reviews the budgetary processes
within the Railways bringing out several dysfunctionalities,
adding to those already pointed out by Sriraman in Section
5.3. Dividends, investments, and fund raising through the
IRFC are non-transparent, politically influenced
administrative decisions over which the Railways seem to
have little control. Similarly, the pricing and cross-subsidies
which are known to be very large can hardly be estimated
given the non-transparent methods followed and the lack
of appropriate accounts and measures. Perhaps one of the
least known aspects is the cost of the Railways policy of
giving free travel passes to their employees and pensioners.
Given the very large numbers of people who are employed
and the generous number of times they and their families
can travel, the value of the traffic lost as a result is close
to 13 per cent.
Much is wrong with the Railways’ investment and
expenditure processes. Their are highly politicized and
have moved far from both social and financial optimality.
The author makes many suggestions that can improve the
functioning of the railways and bring about expenditure
accountability such as commercial orientation, greater
autonomy to the board, flexible pricing, full utilization of
all assets, usage of trains as marketing platforms, usage of
railway lands, and going after the better paying customers.
CONCLUSION
Bringing about expenditure accountability is a continuing
task. A paradigm shift in the expenditure process that
gives adequate incentives for proper management of
expenditures and elimination of the incentives that favour
wastage is urgently necessary. That would inter alia mean
moving away from the current system of plan allocations,
dual budgeting and the incremental basis. We have
highlighted the importance of decentralization within
government, powers that match the tasks assigned, more
flexible and scientific procurement processes, incentive
compatible delegation and inter-governmental fiscal
relationship compatible with expenditure control,
transparency in budgeting, bringing to the fore the much
abused ‘off-budget items’. A workable movement towards
this would have to be combined with privatization and
a greater role for the private sector where its has
comparative advantage. In conjunction, there is also a
need for activist strategies that take private investment
forward through PFIs.

REFERENCES
Morris, S. (2001), ‘Issues in Infrastructure Development
Today: The Interlinkages’, in 3iNetwork, India Infrastructure
Report 2001: Issues in Market Structure and Regulations,
New Delhi: Oxford University Press.
Morris, S. (2002), ‘The Challenge of Governance in
India’, in 3iNetwork, India Infrastructure Report 2002:
Governance Issues for Commercialization, New Delhi: Oxford
University Press.
Overview 17
3iNetwork (2001), India Infrastructure Report 2001:
Issues in Market Structure and Regulation, New Delhi:
Oxford University Press.
3iNetwork (2002), India Infrastructure Report 2002:
Governance Issues for Commercialization, 3iNetwork, New
Delhi: Oxford University Press.
Upadhyay, Videh (2002), ‘Panchayats and Paper Laws—
Simmering Discontent on 73rd Amendment,’ (EPW
Commentary), Economic & Political Weekly, July 20.