SynopsisFor any development finance institution to be viable, two things have to be in place — funds that would be available for 10-15 years, and projects that earn income for the investing institution. The framework, as announced by Sitharaman on Tuesday, is sketchy for now.
India’s quest for funds to build infrastructure is never ending. Over the decades, it has taken many forms, but almost every one of them ended up in failure. With Nirmala Sitharaman announcing on Tuesday that the Union Cabinet has cleared a Bill to set up a GoI-owned development finance institution (DFI), here comes another go at it.
To be sure, this is not the first time that a development finance institution is being set up. After the Industrial Development Bank of India (IDBI) was conceived in 1964, similar institutions sprung up — the Industrial Credit and Investment Corporation of India (ICICI) and the Industrial Finance Corporation of India (IFCI). Leaders of ICICI and IDBI threw in the towel in the 1990s stating that there was no future for such lenders. IFCI has faded into oblivion.
But that did not stop the government of the day to come up with more of the same — the Infrastructure Development Finance Company (IDFC), which also converted into a bank, parroting what its predecessors said. India Infrastructure Finance Company Ltd (IIFCL) is now being absorbed into its latest avatar. Once these institutions retreated, State-owned banks were directed by GoI to step in to fund infrastructure.
The result: the state-run banking system lies in the ICU after gobbling up more than Rs 3 lakh crore of taxpayer money in the past few years.
Early explorers usually travel blind knowing very little about the path to their destination. But subsequent travellers are wiser by the experience of their predecessors’ mistakes.
The failure of institutions like IDBI and ICICI, which turned into banks, has some lessons for the journey this government has begun.
For any development finance institution to be viable, two things have to be in place — funds that would be available for 10-15 years, and projects that earn income for the investing institution. The framework, as announced by Sitharaman on Tuesday, is sketchy for now. But what is clear is that the State would own a stake and seek funds from long-term investors like pension funds, insurers and global investors.
International investors aren’t charity outfits, but look for handsome returns, say, 12-14% or even more on their investments, if past choice is an indication.
These are mostly funds of international insurance and pension funds, and some sovereign wealth funds. Is it worth the effort to provide guarantees and returns to get their capital? Or is there an alternative with domestic savers? If savers from the US, Canada and Australia can earn 12% or more, why not the local pension fund contributors?
If GoI is guaranteeing the return of funds, it would be preferable to provide them to domestic savers.
Insurance companies, pension funds and even individual savers wouldn’t hesitate to buy bonds floated by the new institution. While Sitharaman mentioned tax benefits without elaborating on the kind, the outer limit of 10 years means they come with an expiry date from the day of its birth.
When the government is throwing incentives to global investors, it could look at reviving taxfree bonds by the newbie. The success of tax-free bonds in 2014-15 from a host of State-run institutions is testimony that domestic investors have enough funds to lend to the State, if only they are made as attractive to them as they are for global investors.
So, how much will the government guarantee? If it is the entire amount, then the rating companies will club it with the fiscal deficit number to assess the sovereign fiscal strength. If the administration comes up with some wishywashy structure, one can be sure that the new development finance institution will face the same fate as IIFCL and IDFC.
While the lenders may get comfortable with the State-backing, it is essential that the projects are viable — roads, airports or sea ports. Some voices in government are talking about the much-abused ‘public-private partnership’.
Most private entrepreneurs don’t have equity. And even if they do, they would not want to lock it up for a decade. Private capital looks for higher returns, not annuities.
The disastrous performance of private infrastructure projects of the last two decades is a lesson that gold-plating by entrepreneurs makes projects unviable. A huge chunk of the bad loans that have become a drag on the banking industry was the fallout of lending to unviable private-led projects. There’s no reason to believe that it won’t happen again if the same model is repeated.
The idea of a development finance institution can be dismissed by some as old wine in a new bottle. But the nation could well savour it if the brew is different.
Views expressed are author’s own