New DFI should not just be a bailout of the old
One of the important announcements in this year’s Union Budget was the government’s decision to set up a development finance institution (DFI) to steer funds towards infrastructure. This decision, though much demanded by industry, has certain major problems. The DFI structure has been tried before in India, and it succumbed broadly to the same problems that plague the public-sector banking system — directed lending, and poor risk evaluation and supervision. Yet, if the government has determined on this course, then it must at least minimise the incentive problems and seek to ensure structural soundness in the proposed institution. The finance minister, in the Budget speech, had promised that the new DFI would be professionally managed. This was interpreted by most observers to indicate it would have a large, preferably a controlling, share for the private sector and the management would be selected accordingly. The logic for a DFI has, from this view, a certain power: The government’s stake would serve to de-risk the entry into long-term infrastructure finance in India for otherwise risk-averse pools of global capital. A separately rated entity would also ensure that borrowing for infrastructure would not be held hostage to the concerns now being expressed about government debt in India.
However, it now transpires that state-controlled India Infrastructure Finance Company (IIFCL) will serve as the seed for the new DFI. The paid-up capital of IIFCL, which amounts to Rs 10,000 crore, will be supplemented by the additional Rs 10,000 crore set aside by the Budget. Bad loans made by IIFCL will be provided for and then the books will be transferred to the “new” entity. This appears to be another idea that has unfortunately been colonised by bureaucrats. If IIFCL could have done the job that the government wants the DFI to do, it would already be doing it, and there would be no need for a further intervention. What is being proposed is a travesty: A bail-out of IIFCL and a renaming, alongside a line of credit that will probably allow the new institution to repeat the mistakes of the old. It is hard to see how and why any private-sector pool of long-term capital would want to go into business with such an institution.
It is understandable if, as an initial time-bound mechanism while funds are raised from the private sector, the new DFI retains a majority stake by the government. But the ambitious target of Rs 5-trillion financing in just three years set out by the finance minister will require this to become dominated by private-sector money fairly swiftly, with government ownership reduced to minority. Majority government ownership will also not provide enough flexibility to hire people with required skills from the market. The initial structuring of the institution should thus be done with all this in mind. It should start with a clean slate and not inherit any of the problematic institutional history associated with the current institutions like IIFCL. The finance ministry must swiftly rethink its draft legislation for the DFI if this is not to be just old wine in a new battle — tasting as sour as it did in the past.