Shreyas Ernest Isaac

Introduction

The Department of Economic Affairs, under the Ministry of Finance, runs the ‘Viability Gap Funding’ scheme, which was notified initially in 2005, and was later revamped in 2020. The scheme enables PPP projects which are socially and economically desirable, but may fall short of financial viability for private firms to invest in (as public infrastructure projects usually have longer gestation periods and may not always give high financial returns). The VGF Scheme allows for the expansion of public infrastructure projects into the provision of goods and services in the social sector, including waste water management, education, healthcare etc. In its present state, the scheme allows for up to 60% of the total project cost of projects in the social sector to be subsidised and up to 80% of the total project cost of pilot projects in education and healthcare to be subsided by the central government. For all other sectors, projects are eligible for up to 40% of the total project cost as viability gap funding. The scheme is administered by an empowered committee and proposals need to be approved by this committee before funds are disbursed (Department of Economic Affairs, 2020). Most recently in 2024, the union government launched a separate VGF scheme for off-shore wind energy projects, in a bid to boost the generation of renewable energy production in the country (PIB, 2024).

The economic tools which work in favour of a VGF scheme

The argument in favour of a VGF scheme stems from an economic concept called an ‘externality’. An externality is when someone who is not a part of an economic transaction, either gains a benefit or suffers a loss due to the economic transaction, without having to pay for the benefit or being compensated for the loss. Externalities can negative or positive, and it is the positive externalities that are produced by infrastructure projects that justify the VGF scheme. An example of this could be the construction of a metro line within a city, that would increase the property prices across its route. Owners of property along the route would have greatly benefitted from the increase in property prices, without having to do anything. The problem however is that societies generally would tend to under-produce goods which provide positive externalities. This problem of under-production can be boosted through subsidies from the government, which would push the supply curve rightwards, leading to an increase in the production of the good. The basis of this comes from the work of noted welfare economist Arthur Cecile Pigou- a subsidy which corrects a market failure that occurs in the under production of goods that provide positive externalities are commonly referred to as ‘Pigouvian Subsidies’.

Social Marginal Cost and Private Marginal Cost

Whenever there is a good that produces a positive externality, on the supply side there would be under-production, as the private marginal cost curve (which shows us how much it costs a private firm to produce one extra unit of a good), would be left of the social marginal cost curve (which tells us how much it costs to the society to produce one extra unit of a good). The aim of the subsidy would be the push the private cost curve towards the right, which would increase the total quantity produced (As seen in Figure 1). The aim would be to reduce the under-production of the good, by lowering costs to firms. Without the subsidy being made available, there would be a deadweight loss in the economy, as the society is quite literally ‘paying’ for the lack of production of a good which produces a positive externality. The subsidy would move the market equilibrium, which occurs at E0, towards the socially optimal equilibrium at E1, thereby removing the market failure (Stiglitz & Rosengard, 2015 pp. 129-131). While it would be hard to bring the market equilibrium to exactly the position of the socially optimal equilibrium, it is nonetheless an effort to at least move towards the socially optimal level (Q1 and P1).

Figure 1- Market Failure in the Case of Positive Production Externalities

*Diagram has been complied by the Author

Recommendations and Conclusion

Infrastructure is an essential component in the process of growing an economy, and infrastructure projects need to be at the centre of any government’s economic policy. The VGF scheme enables the scope of PPP projects in India to expand beyond the traditional sectors in which PPP projects have normally thrived in, such as highways, airports etc and it plays an important role in correcting the market failure that occurs due to the under-production of goods that cause positive externalities in the society. Any increase in the funding and scope of the VGF scheme, would go a long way in improving the PPP eco-system in the country, apart from increasing the efficiency of the public service delivery system in India. Dedicated targeted VGF schemes for certain sectors (including climate resilient infrastructure, projects which have a direct impact on the SDG’s etc), can also be a boost for the PPP model of service delivery in the country.

References

Department of Economic Affairs, Ministry of Finance. (2020). VGF Scheme Guidelines. Government of India. https://www.pppinindia.gov.in/report/vgf-guideline_1691500048.pdf

Press Information Bureau. (2024). Cabinet approves Scheme for Viability Gap Funding for Battery Energy Storage Systems (BESS). Government of India. https://pib.gov.in/PressReleaseIframePage.aspx?PRID=2026700

Stiglitz, J. E., & Rosengard, J. K. (2015). Economics of the Public Sector (4th ed.). W.W. Norton & Company, Inc.