On March 25, the last day of the Covid-19 curtailed Budget Session of Parliament, the government passed a Bill that turned the clock 30 years back to India's pre-economic-liberalisation era in terms of infrastructure financing.
The proposed law that the Rajya Sabha cleared that day (the Lok Sabha had passed it two days earlier) was the National Bank for Financing Infrastructure and Development (NBFID) Bill, 2021. It called for the establishment of a development finance institution (DFI), a tried and tested concept that had led to the birth of institutions, including IFCI (Industrial Finance Corporation of India), IDBI (Industrial Development Bank of India), SIDBI (Small Industries Development Bank of India), NABARD (National Bank for Agriculture and Rural Development), etc., in the past.
The concept of statutory DFIs was junked by the Narasimha Rao government in 1991 and those that came into existence since then have been corporate entities registered under the Companies Act - institutions such as IDFC (Infrastructure Development Finance Company) and IIFCL (India Infrastructure Finance Company Ltd) - and not organisations created through special legislations.
The enactment of this law has cleared the way for the birth of NBFID, the first Parliament-backed institution for infrastructure financing in three decades. If all goes according to schedule, setting up of the institution, appointment of its board of governors and operating management etc should be over by the second half of 2021/22.
The government says the new institution will have a unique shape and structure based on the lessons learnt from past experiences. But, despite the assurance, one big question remains: What is the real hurdle before India's infrastructure financing - Is it the absence of a credible institution? Shortage of funds? Lack of viable projects? Or is it a combination of all these? There are no easy answers. But the success of the new DFI will depend on multiple factors.
On February 1, while delivering her Budget speech, Finance Minister Nirmala Sitharaman announced the decision to introduce a Bill to set up a professionally managed DFI to act as a provider, enabler and catalyst for infrastructure financing. She budgeted Rs 20,000 crore to capitalise the new institution and set a lending portfolio target of Rs 5 lakh crore in its first three years. Fifty three days later, as the Budget session got over, Sitharaman had the Bill ready, and passed. But during a brief discussion on the day the Bill was introduced in the two Houses, it was not even subjected to customary scrutiny by any standing committee or select committee of Parliament.
The law was enacted in a hurry as the success of the government's mega plan - the Rs 111-lakh-crore infrastructure investments over a period of five years - partially depends on the resources NBFID can raise. A National Infrastructure Pipeline (NIP) with over 6,500 projects in the areas of transport, energy, water, telecommunications, sanitation, commercial infrastructure and social infrastructure, including education and health, are ready, and are waiting for funds, to take off. "Purely public funding and taxpayers' money alone cannot meet that kind of money for building the infrastructure of the country. Through the establishment of this unique organisation, we will probably meet about 8-10 per cent of the expected expenditure of the NIP itself," Sitharaman had informed the Lok Sabha.
This is what the new institution aims to achieve - It will raise money, provide loans and be an underwriter; it will create markets for bonds, derivatives and other important instruments for infrastructure financing; project structuring and monitoring services and technical assistance will be part of its mandate. Overall, NBFID will be an ecosystem architect for infrastructure financing. The government has promised operational autonomy and protection from oversight agencies, including Central Bureau of Investigation (CBI), Central Vigilance Commission (CVC) and Comptroller and Auditor General of India (CAG). It will offer some incentives in the form of grants, guarantees and concessions to attract investors. Starting off with 100 per cent government equity, the institution will see dilution of 74 per cent stake by attracting investments from multilateral institutions, sovereign wealth funds, pension funds, insurers, financial institutions, banks, etc. over a period of time.
Experts believe it is time for a DFI, though the country's infrastructure finance needs will not be the same as that of the early post-independence years.
"Post-independence, we had very few large business houses. The British had left and there was a shortage of industrial capital. DFIs of that time (IFCI, ICICI and IDBI) did enormous work by creating a new class of Indian businessmen who are today listed on stock exchanges and own/run very successful companies. By 1990s it was very clear that new forms of finance had become available, and therefore the DFI system was not required for industrial capital," says Vinayak Chatterjee, Chairman, Feedback Infra.
What happened in the 1990s was that most dedicated development finance institutions became commercial banks and long-term infrastructure investment funding became part of mainstream banking. Other forms of private capital also became available for infra-funding.
"In the past when banks were getting liberalised, we saw narrowing of services provided by DFIs, NBFCs and banks. Hence, they were made to merge, become banks. At that time banks were strengthening and DFIs were weak, so it made sense to merge them with banks which were growing. Now we are seeing a reversal. Banks are getting weaker and weaker over a period of time, and in the process, one of the elements of the banking industry, which was lending for long-term infrastructure investment, is taking a backseat," says N.R. Bhanumurthy, Vice chancellor, Dr B.R. Ambedkar School of Economics, Bengaluru.
There were multiple reasons why banks started weakening, including missteps some of them took, leading to large non-performing assets (NPAs) and bad loans and liquidity crunch in the sector. The quality of projects became suspect and long-term investments in sectors such as energy and power become too risky, making banks averse to funding such projects.
"We have come full circle now. We started with strong banks and weak DFIs, now it is weak banks that are not able to perform the role of DFIs. There is also a tendency to reduce the role of public sector banks. Given all these things there is certainly a need for having some institution, which can focus on long-term investments," adds Bhanumurthy.
Chatterjee puts it in a different way. "Since the beginning of the 21st century India has had enough capital for industry and services, but there has been a shortage of long-term developmental capital for public works and large impactful infrastructure projects. NBFID is being created to address this problem. One should not relate this DFI to the older ones. The earlier one was for industrial capital. This one is for public works and infrastructure capital," he says.
"The Bill is targeting those areas where private capital has no role to play. This DFI is a development fund looking at economic returns (through creation of social capital etc.) distinct from a pure financial return," he adds.
Once its agreed that there is space for a new DFI, the next question is how to capitalise it, and manage funds without any of the problems faced by banks and non-banking financial companies (NBFCs) in their attempts to fund development finance. Are government concessions good enough?
Sitharaman is confident that both global institutional investors and domestic retail investors will be keen to participate in the project. The money that is expected to be raised from sovereign funds globally and also from other big investors who want to invest in India will all be drawn towards this institution, she says. The government has already approved a grant of Rs 5,000 crore in addition to the Rs 20,000 crore it is ready to put in as equity. The grant is expected to reduce the cost of funds in lieu of potential cost savings expected from the issue of tax-free bonds. Unlike commercial banks, the new institution can access the line of credit directly from the Reserve Bank of India (RBI). The Bill also talks about a framework where the RBI will be enabled to issue regulations for granting licences to other infrastructure-focussed DFIs. While DFIs will enjoy an income tax exemption of five years, it will be 10 years for NBFID.
"For just one bullet train project, the Japanese have given Rs 1 lakh crore for 60 years at 0.5 per cent interest with a 15-year moratorium. This is what I call developmental finance. Now for one project if we can raise Rs 1 lakh crore, will there be a problem in raising Rs 5 lakh crore for the nation?" asks Chatterjee of Feedback Infra.
According to the Bill, the plan is to apply for, receive, accept, administer and manage grants, aids, subsidies, funds or donations, etc., from national and international sources, including World Bank, New Development Bank, Japan International Cooperation Agency, United States Agency for International Development, European Investment Bank, Asian Development Bank, International Finance Corporation and other organisations.
Shubham Jain, Senior Vice president and Group Head of rating agency ICRA, says the success of the new DFI is not only about having long-term capital. "There is no dearth of capital in today's times. In fact in operational projects, we have such a good track record that India has been able to attract long-term investors, including marquee names like Ontario Capital, Teachers Fund, etc. But if you look at their investment portfolio you will not find greenfield investments. Why? They don't want to take exposure because they know the risks involved. The projects can get stuck at various approval levels," he adds.
While there are several operational reasons for such projects getting stuck, experts cite regulatory hurdles as one of the common issue plaguing the infrastructure sector. For instance, various authorities are in charge of roads, airports, ports, real estate, etc. If these authorities are not able to provide enough protection to lenders or investors, their interests in such projects decline. Even though concession agreements are very clear in terms of obligations and the rights of various parties, the timeliness and fulfilment of all those obligations mostly remain in letter and not in spirit, thereby impacting investor interest. A new bank, if it puts money into the same system, might end up having the same issues.
ICRA's Jain says the government has been taking lots of initiatives to address such issues. "HAM (hybrid annuity model) is one such intervention where for the first time they provided the termination payment even during construction. What they said is okay, even at the construction stage, if something goes wrong in the project, where the lender may have disbursed 60, 70 per cent or whatever amount, if the project has to be terminated because of any reason, the authority will pay the termination payment," he explains.
C. Rangarajan, Former Governor, RBI, also feels the new DFI is worth trying out, though its success in the early years largely depended upon the government and the RBI providing resources at a lower rate of interest. "Without that the model would not have worked. But as we moved into 1991, to a newer regime, we felt the bond market would develop, while long-term funding would be met by the capital market. However, the bond market has not developed the way we thought it would in the early1990s," adds Rangarajan.
According to Rangarajan, while the Central government looks to set up another institution, a combination of government support and development of the bond market - which is what the new DFI is trying - could work.
While the government itself provided the initial capital earlier, it might be difficult to do today since the Centre also needs to recapitalise banks in a big way. "As we move along, more credit needs will require more capital for banks also, and that will be the first priority of the government. As credit moves further up, recapitalisation will also become necessary. At some stage, the government will have to see whether its direct participation is needed," says Rangarajan, adding, everything will depend on how much money the new institution is able to raise from the market, even in the form of equity.
Also, one of the important subscribers of the bond market are long-term suppliers of funds like insurance and pension funds, and if the bond market really develops, they can come in. "All of these depend on the confidence the institution is able to build. The institution will have to be run efficiently and it is important that what happened to banks, the accumulation of non-performing assets (NPAs), doesn't happen to the institution. The correct assessment of the projects and their viability are all that will be required. If long-term suppliers of funds, including insurance and pension funds, see that the institution is moving in the right direction, probably capital will come in. The confidence has to be built and that is when the bond market will develop as well," according to Rangarajan.
Kavaljit Singh, Director of Madhyam, a Delhi-based public policy research institute, says the setting up a new DFI is the easiest part. "It is a legislative process. You introduce a Bill and get it passed. Given the majority this government has, there will not be any problem. The problem is once it is established, to run it professionally without cronyism, without corruption, the day-to-day functioning. It is the biggest challenge not just in India, but also in other countries as well," he adds.
According to Singh, in theory at least, DFIs are different from commercial banks. "They have many advantages over commercial banks. Unlike commercial banks they don't operate with the primary objective of maximising profits. They combine profit making with social and developmental objectives. So they have to walk on two legs. That is why it is all the more difficult. You have two objectives. You want to remain commercially viable also while pursuing developmental objectives."
"Most commercial banks in India lend for up to 10 years. And they give working loans. But for construction of rural roads, water supply, sanitation, railway etc, you need long-term financing. Similarly, there are some industrial projects which may take 20 years, 30 years to become profitable, like hospitals, for instance. So infrastructure doesn't mean only physical infrastructure, it also means social infrastructure such as education," says Singh. "So, DFIs have a very peculiar role to play. They should not compete with banks because they can't, their role is something else. Now, in India there are good DFI lending practices, and there are bad ones as well. Infosys is a product of DFI. That's a good lending practice. Then we have Jaypee Greens and HUDCO, whose primary objective is to provide low-cost housing to the poor, upgrade the slums. Now, they have funded a golf course, that's a bad practice. So there are all these good, bad, ugly practices. So, the running and the governance, matters. There lies the challenge," he adds.
The Worry And The Defence
Former Finance Minister P Chidambaram is of the opinion that the government should examine the performance record of existing DFIs and identify shortcomings before building a new one.
"There are DFIs working today with mixed results. The National Bank for Agriculture and Rural Development (NABARD) is in effect a DFI for agriculture-related infrastructure. The National Housing Bank (NHB) refinances housing finance companies and does direct lending to housing schemes. IRFC Ltd finances railway projects. These are effectively DFIs. The UPA started IIFCL to refinance as well as directly lend to infrastructure projects. Without examining their record and identifying shortcomings, there is no purpose in floating another DFI," he says.
It's not just the effectiveness that is being questioned, the model in which the government attempts to protect NBFID from the scrutiny of all investigating, regulatory and audit agencies such as the CBI, the CVC and CAG has raised eyebrows both within the Opposition benches of Parliament, and outside. They feel that one of the largest banks of the country with a loan book of some Rs 20 lakh crore or Rs 30 lakh crore eventually, should be subjected to external oversight.
Sitharaman says NBFID will be answerable to Parliament. "We are not going from one extreme to the other extreme where there is no oversight at all. But that heavy fear of taking decisions as a result of oversight is now being given space wherein legitimate commercial decisions can be taken, professionally. There is a separation of government control, government ownership and government decision-making. The decision-making here runs through a complete professional route. Therefore, to say that there is a complete lack of answerability, lack of absence of transparency is not right. They are going to be answerable to Parliament," she argues.
For the time being, the government has brushed aside criticism. One reason for that is despite all the concerns and differences, every stakeholder agrees that there is an urgency to raise more funds to finance the country's ever-increasing infrastructure needs. Existing funding mechanisms and institutions are proving to be insufficient. A new developing financing ecosystem is essential. A new apex DFI, therefore, needs to be tried out.
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