Hyderabad: Three decades since liberalization, India is finally keen to create a modern financial market, with adequate long term debt options. Apart from benefitting infrastructure building; the initiative, if successful, will de-risk the financial system from NPA shocks.
In the 1973 Hindi film ‘Saudagar’, homemade ‘Gur’(jaggery) seller Amitabh Bachchan, realized the worth of Nutan, whom he once divorced for a pretty Padma Khanna, once the customers rejected his produce.
The finance minister Nirmala Sitharaman’s decision to recreate a Development Finance Institution (DFI), with Rs 20,000 crore initial capital, and leave space for more such institutions in private ownership; relived the Saudagar moment in infrastructure financing and much more.
Three decades since liberalization, India is finally keen to create a modern financial market, with adequate long term debt options. Apart from benefitting infrastructure building; the initiative, if successful, will de-risk the financial system from NPA shocks, and increase FII (foreign institutional investor) inflow, particularly from pension funds.
Dasmunsi proved correct
DFIs were very much a part of India’s financial landscape till 2003, when Infrastructure Development Bank of India (IDBI) Act, 1964 was repealed by the Parliament.
IDBI was a premier DFI, which was then acting as the regulator of two more large DFIs – Infrastructure Finance Corporation of India (IFCI) and the Industrial Credit and Investment Corporation of India (ICICI) – and other such smaller institutions.
The decision was foretold way back in 1998, when two high profile expert committees headed by former RBI governor M Narasimhan and IDBI chairman S H Khan recommended universal banking and scrapping of the virtual monopoly of DFIs over term loans.
Acting on the reports the government first allowed banks to start term lending. ICICI seized the opportunity and opened a bank. It was then a mere formality to repeal the DFI regulatory act.
Experts argued that the US operated without a DFI. At least one MP, the late Priya Ranjan Dasmunsi of Congress, opposed the move in the Parliament. He wanted the government to rethink. Two decades later, Dasmunsi proved correct.
Serious flaw
In the banking parlance term loan is a ‘sans-recourse loan’. It means such loans are not backed by balance-sheet and is therefore risky. However, such loans are crucial for a growing economy, where smaller entrepreneurs without much financial asset aim it big. Closing this window means loans will only be directed to big groups and for less-risky projects.
Haldia Petrochemicals, promoted by a professional-turned-entrepreneur, is a classic example. Many thermal power plants, built by lesser-known promoters, in the last decade, availed term loan facilities.
The BOOT (build-own-operate-transfer) projects, which was common in highway infrastructure building, needed term loan.
A BOOT developer gives guarantees to the extent of mistakes from his part. But he cannot be held responsible for delay in land acquisition or poorer toll collection than projected. And, projections go wrong, the lender does not have many options to recover the money.
To cut the long story short, term-lending is a specialized task. While liberalization in the banking sector was justified, both Atal Bihari Vajpayee government (1998-2004) and Manmohan Singh government (2004-2014) failed to create space for such specialists.
The country didn’t have a long-term bond market. Restrictions from RBI on credit enhancement acted as a regulatory hurdle in creating such a market. Employees’ Provident Fund Organisation (EPFO), which is operating on socialistic principles, made the growth of market-driven pension funds difficult.
The result was catastrophic. A swarm of small-sized banks joined the mad-rush for term lending in consortium during the boom between 2004 and 2009. They were using short-term (two to three year) deposits in investing in Highway building where returns are spread over 15 years.
And, as highway projects suffered land acquisition delays etc or power plants failed to sell as much electricity at a remunerative tariff as expected, everyone suffered. As the payback suffered, developers became bankrupt. Banks piled up huge NPAs.
No term-loan
The net result is, today banks are flooded with cash but they almost stopped giving term loans. They do finance projects but of companies with strong balance-sheet. In banking parlance this is referred to as corporate loan. Cash is safely parked with RBI for an assured return.
The problem dogged the Modi government as soon as they gave an infrastructure push beginning 2014. To solve the riddle the Modi government first tried Hybrid Annuity Model (HAM) which assured a part of the projected revenue to the private sector BOOT developer.
However, this too failed to impress banks and the government finally moved to EPC (engineering, procurement and construction) model, where National Highway Authority (NHAI) or the National Highways and Infrastructure Development Corporation (NHIDCL) funds projects. The private sector operates as a contractor.
Considering India’s deficit finance and a huge need for infrastructure building, this is not an efficient model as it limits the fund availability to the extent of the balance sheet capacity of NHAI or NHIDCL.
Developed countries do not suffer from as much head-wind, particularly in land acquisition, in infra building. Moreover, the US has a thriving bond market. Australia has a rich project monetization industry.
Project monetization
In her Budget proposal, the finance minister targeted three areas:
First, the government is now aiming to promote project monetization. It means completed projects from the National Infrastructure Pipeline will be put on the block and be given to private promoters for a value. The private sector will generate returns from users.
This will unlock value and strengthen the balance-sheet of the executing agency like NHAI or NHIDCL, thereby improving their creditworthiness, which in turn will pace up future infrastructure creation. This is a new concept and may take time to mature. But the move is appreciable.
Sitharaman is equally keen to see a debt market is emerging. However, that’s not going be a cakewalk. To start with, she proposed the creation of infrastructure investment trusts and real estate investment trusts which are expected to create long term investment options for portfolio investors.
These are exploratory steps and the success of such initiatives will depend on many implementation issues including the regulatory ecosystem in the particular industry. The sustained political will and policy consistency will play a key role.
However, the government underlined its commitment to reviving the culture and expertise of term loans by proposing setting up a DFI. The very mention of the private sector indicates that the government is interested in playing the role of an enabler, not a monopolist.
And, that’s the best news for the moment. The presence of the government spoils the loan culture and public sector banks (PSBs) are the perfect example of that.
Meanwhile, the consolidation of PSBs will also create scope for term lending. State Bank has proven expertise in the field. With the government now focusing on creating the right ecosystem, big banks may shed the inertia and may tap the emerging opportunity.
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