Job creation has been the topmost priority of the Indian government. Infrastructure has the highest potential for its direct and trickle-down effect in creating new jobs. However, the challenge that gets in the way is a lack of private investment.
One sure way of attracting private investment in the public sector is to ensure easy availability of long-term institutional credit, which ordinarily should be the forte of development financial institutions (DFIs) such as the original IDBI, IFCI and ICICI.
The government promises to spend 100 trillion rupees on infrastructure over the next five years. However, according to the CMIE CapEx database, leave alone fresh investments, even the value of infrastructure projects under implementation for 2018-19 is just 61 trillion rupees (US$85 billion), of which 45 trillion rupees is public and only 16 trillion rupees is private investment. Given the limitations in raising additional taxes and the likely breach of the fiscal deficit target, the share of private capital in infrastructure has to increase significantly.
Private capital will flow to infrastructure only when there is an assurance of easy availability of long-term institutional finance. The looming threat of asset-liability mismatch in lending to long-term public infrastructure projects, where investments are front-loaded and returns back-ended, will continue to discourage commercial banks. The commercial banks are already saddled with huge non-performing assets (NPAs), most of them arising out of infrastructure sector.
Hence the urgent need to reopen DFIs to provide long-term institutional credit.
With the adoption of the public-private-partnership (PPP) model since the mid-1990s, private-sector participation in infrastructure has increased manifold. The strategy of bank-led financing for infrastructure tried in the early 2000 saw phenomenal growth in institutional credit during the period 2003-2008. This period had benign low interest for fairly long periods. The exciting combination of the government’s push for infrastructure projects, encouragement to the private sector and a low-interest regime resulted in some exuberant financing by commercial banks to many inexperienced players putting the viability of projects at risk.
Many civil contractors graduated as project owners. Coinciding with this boom period and unable to compete with commercial banks in the low-interest regime, the DFIs – ICICI, IFCI and IDBI – transformed themselves as universal banks. Flush with funds, the commercial banks, with little experience in long-term project lending, enthusiastically grabbed the opportunity in long-term financing, albeit without enough experience for such.
After the 2008 financial crisis, to keep their economies growing artificially, governments the world over deliberately chose to have a loose monetary policy. Excess liquidity in the system led the commercial banks to competitive financing, often deviating from the rigorous discipline of credit appraisal and due diligence. Consortium lending by banks, a method to spread the risk, in reality degenerated into an alibi to shirk responsibility.
This created excess capacity in the system. When the US Federal Reserve tapered its expansionary monetary policy, the low interest rates in India reversed, spelling doom for many infrastructure players. NPAs piled up in the balance sheet of the banks. The share of NPAs in this sector increased from 16.7% in March 2017 to 22.6% by March 2018, amounting to about 10.3 trillion rupees. From 2014 commercial banks started reducing their exposure to this sector.
All this hindsight analysis is not to argue that DFIs would have saved the day. It is only that being long-term players, they would have had different accounting norms for NPAs and different regulatory treatment. They would have acted as benchmarks for long- term project lending.
Since 2014, sensing a vacuum in project lending, in a misplaced urgency to grow their balance sheets and taking advantage of the slack regulatory environment, some of the non-banking financial companies (NBFCs) tried filling the space vacated by commercial banks. By sucking funds from supposedly investor-safe financial industries like mutual funds and pension funds, these NBFCs lent for long-term projects. This misadventure landed some of the NBFCs on the wrong side of the asset-liability match.
These experiments in infrastructure financing models has brought us to a crossroads. We should consciously have a relook at reviving the long-term DFIs.
It is time to acknowledge the avoidable stress put on the financial sector by the current system of long-term project financing through commercial banks. The Reserve Bank of India put up a discussion paper in April 2017 on the desirability and feasibility of wholesale and long-term finance banks but not much seems to have been done. The minimum capital requirement prescribed by the RBI for wholesale and long-term finance is 10 billion rupees. When the total write-off for NPAs in financial year 2018 alone was 1.28 trillion rupees, it should not be a problem having at least two-thirds well-capitalized wholesale and long-term finance, fully funded by the commercial banks.
One serious concern for DFIs is the cost of funds. Time-tested approaches like exemption on interest earned on investment in infrastructure bonds, and innovations like exemption from CRR/SLR (cash reserve ratios and statutory liquidity ratios) should reduce the cost of funds. Available technology and managerial skills should considerably reduce the overhead costs of DFIs. Revenue-generating activities like investment banking services by these DFIs should help improve their net interest margins. Recent reforms in the financial sector like the Indian Bankruptcy Code and National Company Law Tribunal will ultimately address issues faced by DFIs.
Professionally run DFIs will mobilize, channel and multiply the finance available to the infrastructure sector. This will pave the way for the time-tested path to job creation.