The Narendra Modi cabinet has cleared a bill to set up a government-owned Development Finance Institution (DFI), called the National Bank for Financing Infrastructure and Development, which will be set up with a corpus of Rs 20,000 crore and an initial grant of Rs 5,000 crore.
The initial capital will be used to raise up to Rs 3 lakh crore over the next few years for financing infrastructure investment.
The intent behind setting up a DFI is to provide long-term financing for infrastructure. Infrastructure projects are complex, capital-intensive, and have long gestation periods that often pose risks to project financiers. The scale and complexity of infrastructure projects make financing a challenge. There are difficulties in bank-led financing of infrastructure; their liability profile is not suited for financing long-term high-risk infrastructure projects.
Between 2003 and 2008, the bank-led strategy for financing infrastructure projects was tried. But the global financial crisis, and the recession in the economy since 2012, made repayment of loans difficult. The following period saw a spurt in non-performing assets (NPAs). The RBI’s latest Financial Stability Report has projected that the non-performing assets of banks could rise from 7.5 per cent in September 2020 to 13.5 per cent by September 2021. Banks’ ability to finance infrastructure projects is impaired.
Allow long-term financing from domestic & external sources
The idea of setting up a Development Finance Institution to fund infrastructure projects is not new in India. In the 1950s and 1960s, a series of such institutions were set up to cater to the long-term finance needs of the industry. DFIs received subsidised credit from the government and the RBI. The bonds issued by DFIs qualified as SLR (statutory liquidity ratio) investment by banks.
With the withdrawal of the subsidised credit in the early nineties, the DFIs were forced to borrow from the market. In the absence of a strong debt market, the DFIs did not have access to cheap funds. This severely curtailed their ability to lend to industry at competitive rates. Many of the DFIs later had to be turned into commercial banks.
The DFI model has made a comeback. To ensure that the proposed institution is able to finance infrastructure investment, it should be allowed to raise long-term financing from domestic and external sources. The DFI should be allowed to tap the pools of capital in the form of pension funds, insurance companies and mutual funds. The government is reportedly planning to provide a 10-year tax exemption to funds invested in the DFI to incentivise long-term players such as insurance and pension funds. This is a welcome move.
A review of the existing guidelines governing investments by insurance companies in infrastructure is needed to incentivise greater flow of investments by them. Insurance companies are required to make the bulk of their investments in high-rated bonds, and bonds issued for infrastructure financing, including those by the proposed DFI, may not get AA or AAA rating. These regulatory prescriptions need to be reviewed to ensure greater interest by long-term investors, such as insurance and pension funds.
The proposed DFI should also be allowed to raise long-term financing from external markets and from multilateral financial institutions. The grant of Rs 5,000 crore could provide for the hedging cost. The DFI will also likely have sovereign guarantee to garner resources from external sources. While the initial grant could suffice to cover hedging costs at initial stages, in the medium term, we need a deep and liquid bond market along with instruments to hedge currency, credit and interest rate risks.
Sound management structure
The proposed DFI needs to have a sound management structure. The government’s commitment to have a professional board with 50 per cent non-executive members is a step in the right direction. The DFI will be expected to support infrastructure projects at different stages of the project life-cycle; it may be required to support institutions such as infrastructure investment trusts and would be required to undertake project feasibility studies.
To make these decisions in a timely manner, the board must be vested with autonomy in decision-making. Immunity from prosecution, market-driven emoluments, and longer tenure for managing directors are crucial for the success of the new avatar of the DFI. The proposed DFI should be able to attract competencies such as those of investment professionals and other experts who are able to assess the project from the development standpoint and the risks involved.
The proposed DFI is expected to provide Rs 3 lakh crore towards infrastructure financing. This is about 3 per cent of the Rs 111 lakh crore expected to be invested on over 7,000 projects as part of the National Infrastructure Pipeline till 2024-25. The proposed DFI could serve as a catalyst to address the infirmities in the bond market. This will facilitate greater private sector players who will be willing to co-invest along with the DFIs to ensure greater infrastructure investment.
While the government will have full ownership of the DFI, it will bring down its stake to 26 per cent over the next few years. This is a positive move. A number of long-term investors like pension funds and sovereign wealth funds could be interested not just as investors in bonds issued by the DFI, but also as stakeholders in it.
Ila Patnaik is an economist and a professor at National Institute of Public Finance and Policy.
Radhika Pandey is a consultant at NIPFP.
Views are personal.
(Edited by Shreyas Sharma)