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India's infrastructure push needs new model, strong state support to succeed


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India's infrastructure push needs new model, strong state support to succeed

The Indian government should bear the regulatory risks and actively invest in building new roads, ports and airports, experts say, as the country seeks to address the biggest drag on its economic growth potential by establishing a new financial institution to fund infrastructure projects.

The Indian parliament in March passed a law to establish the National Bank for Financing Infrastructure and Development, a development finance institution that will aim to have a lending portfolio of at least 5 trillion rupees in three years and seek to attract multilateral institutions, sovereign wealth funds, pension funds, insurers, financial institutions and banks to raise money from the sale of financial instruments backed by state guarantees.

"The consensus view is that underinvestment in infrastructure is one of the biggest binding constraints on raising the growth potential of the Indian economy and improving competitiveness," said Alok Sheel, RBI chair professor in macroeconomics at the Indian Council for Research in International Economic Relations in New Delhi.

India plans to spend up to 111 trillion rupees over the next four years on infrastructure projects as it seeks to pull itself out of its latest economic funk when the drag from the coronavirus pandemic pulled the nearly $2.6 trillion economy into its first recession on record. The nation's infrastructure push will cover not just roads, railways, ports and airports but also projects in renewable energy, agriculture, as well as industrial and social infrastructure.

The Narendra Modi government was targeting to grow India into a $5 trillion economy by the middle of the 2020s by investing heavily in infrastructure. While the COVID-19 outbreak may have set those plans back, the aim has not been officially abandoned.

State funding

Mobilizing private finance for infrastructure is challenging, as these projects have long gestation periods, are high risk and generate low returns, Sheel said. The experience of developing countries has been for the state to play a major role directly and indirectly through a combination of direct public investment, subventions to private players and tax breaks. Even in liberalized financial markets, given the nature of infrastructural investment, the state would still need to have a major role, Sheel said.

The timing of the planned development finance institution is right as the appetite of the private sector to invest in infrastructure projects has diminished and the banking system is not in a position right now to support the massive development plan, Sandeep Upadhyay, CEO of Centrum Infrastructure Advisory, told S&P Market Intelligence in a recent phone interview.

"At this juncture, where a large part of the corpus of the banking system is being written off or written down in the infrastructure sector, it is not fair to expect that the same banks will be in a position to start lending to these road and power projects again," Upadhyay said. "The demand for financing is huge and supply is limited."

Finance Minister Nirmala Sitharaman said the government has provided 200 billion rupees as the initial capital for the new infrastructure finance institution in the budget for the new fiscal year that started April 1.

Asset monetization

The government is planning to prepare a list of assets that it can sell to raise funds to build new infrastructure, Sitharaman said in her budget speech on Feb. 1. The government now has about 7,400 projects in its infrastructure development pipeline, of which 217 have been completed at a total cost of 1.10 trillion rupees, she said.

"The government has smartly taken the front seat in terms of capital expenditure [on infrastructure]. ... The risk capital in terms of the development will be put in by the government and they will churn out these investments by monetizing them and selling these assets to the private sector at a later stage," Upadhyay said.

India's economic growth outlook will be an attraction for long-term global investors as global pension funds and sovereign wealth funds seek growth amid record low interest rates that are expected to stay depressed for some time as the pandemic continues to be a drag on the global economy. However, exchange rate risks and India's credit rating may be deterrents.

Attracting foreign capital to fund India's infrastructure will be a challenge, Upadhyay said. "It will only be good assets, attractive geographies which will continue to get this capital," he said, adding, "the biggest part that will be played in terms of attracting foreign capital or high quality investors will be the governance and consistency of policies."

For the new financial institution to be effective, it will be important to see what niche it seeks to serve, said Deepali Seth-Chhabria, an associate director at S&P Global Ratings.

"In our view it could be most effective if its role is clearly carved out and it is provided with the right tools such as establishing strong risk management to manage risk associated with this type of loans," she said.

Mixed bag

Analysts noted that prior attempts at development finance institutions for infrastructure building have had mixed success. Some, including the parent organizations of ICICI Bank Ltd. and IDBI Bank Ltd., were converted to universal banks after starting life as government-backed institutions to fund industrial and infrastructure projects.

More recently, Infrastructure Leasing & Financial Services Ltd., a nonbanking financial company backed by state-run companies to fund large projects, had to be rescued by the government to prevent contagion effects on the entire banking system. The company is now seeking to liquidate its assets to resolve nearly 1 trillion rupees of its debt.

However, even bank funding of infrastructure is fraught with the problem of maturity mismatch -- their cost of funds is lower, but maturity too is short, the Indian Council for Research in International Economic Relations' Sheel said.

Banks often also lack project appraisal skills, as their core competence is in working capital financing. "As a result the banking system has accumulated a large amount of nonperforming assets, much of which are on account of exposure to the infrastructure sector," he said.

The exact mandate of the new development finance institution is yet to be announced but Sheel said that until it is able to develop good project evaluation and monitoring skills, it should be a refinancing rather than a direct lending institution.

As of April 12, US$1 was equivalent to 75.03 Indian rupees.