It is a given that policymakers need to optimise policy across multiple competing objectives. For example, in the power sector, they need to ensure tightest tariffs for buying energy, high capacity addition to address energy deficits, a nod to climate change and therefore renewable energy, diversification of energy sources, power availability for the masses at the most affordable cost, and so on.
The two most important objectives tend to be cost minimisation and capacity maximisation. Unfortunately, these two objectives are opposed to each other. Driving down cost means fewer players will be attracted to the sector, and this drives down capacity addition. To maximise capacity, pricing would need to leave something on the table for investors. Given current sensitivities on corruption, investigations and CAG audits, our bureaucrats believe the most transparent method is to use competitive bidding or auctioning — whether it is for power plants, airports, spectrum, roads or mineral resources.
As a public policy, the objective of minimising tariffs is unobjectionable —but in an infrastructure-starved country such as India, surely, maximising capacity and facilitating growth also have some merit. The secondary and tertiary benefits of infrastructure creation go beyond the immediate impact. Competitive bidding drives down pricing but it also drives down capacity addition, and by itself cannot be the answer to all policy conundrums. When competitive bidding is coupled with rapacious Indian promoters, the problems go beyond the lack of capacity addition.
Competitive bidding incentivises aggressive assumptions and low returns —both of which lead to poor project quality. To make ends meet, companies often use poor quality equipment, take unhedged dollar financing, make aggressive assumptions about the natural resource (for example, radiation in case of solar, or cost of coal going forward), or interest rates.
Many promoters have perfected the art of getting banks, mostly state-owned ones, to fully finance their projects. This leads to two negative consequences. The first is the moral hazard problem. Since the promoter has no invested equity in the project, any risk is worth taking as it is a free investment.
Second, since the projects are effectively 100% debt funded, they have no financial resilience to withstand adverse developments. So, banks get stuck with non-performing assets. The power sector is a case in point where almost 40,000 MW is stuck on account of aggressive assumptions on fuel availability. A huge amount of bank lending is turning sick. This, in turn, leads to reduced risk appetite among banks and reduced credit in the system.
Take the example of the growth of telecom. It is only when we moved to a revenue-sharing mechanism in 1999 that the sector really took off. When we subsequently introduced the bidding mechanism for spectrum and licences, we ran into all sorts of problems. Similarly, the first round of solar bids have left almost 250 MW out of 500 MW in solar thermal unbuilt. The Gujarat solar scheme (a feed-in tariff mechanism) has done what Phase I of the National Solar Mission and multiple states with competitive bidding and L1 matching have been able to achieve over the last three years.
Bidding for power plants is a mess with fuel issues and pricing disputes being rampant. Competitive bidding does lead to many levels of dysfunctional behaviour. While a first round of bidding may lead to maximising cost reduction, subsequent problems are so widespread that next rounds see only poor interest. Despite all this, competitive bidding has become an article of faith with our policymakers.
Policymakers need to have more imagination in designing policies for a growing India. To generate growth, we need to leave something on the table to allow investors to ride through problems that inevitably arise in any business. Only this will facilitate the entry of quality capital and dedicated investors to set up high quality, long term businesses that contribute growth. Else, only those who have perfected the art of creating returns the "Indian way" will thrive.
The many benefits of having more flexible and responsible policies far outweigh the hours of extra sleep for our policymakers.
