If the govt lowers its stake to below 50%, the 3Cs won’t apply to the DFI; how it is staffed will also be critical
RBI clearly can’t give the new DFI’s rupee bonds SLR status since that could derail the government’s borrowing programme; it is unlikely the central bank would want to lend to it directly.
Given how banks burnt their fingers lending for long gestation infrastructure projects, there is room for a development finance institution(DFI) that will help fund India’s ambitious infra build-out. True, the country has had a bad experience with DFIs—IDBI, ICICI, IFCI—which lost unbelievably large amounts as promoters defaulted on their loans. But, there is no reason to believe the new DFI, approved by the Cabinet on Wednesday, can’t be better managed even if it is government-owned. The main problem that banks faced when it came to infra loans was that their liabilities were not of a long-term nature whereas the assets were; this caused a serious mismatch with seriously large amounts of money. Moreover, they were not equipped to assess these long-term projects which were hobbled by delays in clearances and the lack of linkages; they failed to evaluate the risks.
The older lot of DFIs, thanks to their special status, sourced funds at low rates through soft loans from international agencies; with capital controls in place, Indian companies were not accessing the dollar bond market directly. They were also able to access loans directly from RBI under its Long-Term Operations (LTO) fund. The DFIs also enjoyed an advantage in that the rupee bonds issued by them were eligible for the statutory liquidity ratio (SLR) portfolios of banks. RBI clearly can’t give the new DFI’s rupee bonds SLR status since that could derail the government’s borrowing programme; it is unlikely the central bank would want to lend to it directly.
The new DFI is expected to reach out to pension funds and sovereign wealth funds as finance minister Nirmala Sitharaman mentioned; moreover, it could also seek credit from multilateral agencies. While the local rupee bond markets are not deep, there could be appetite from insurers and provident funds especially if the bonds are listed. The overseas bond markets are also an option since the exposures can be hedged.
Since the institution is backed by the government—100% initially, going down to 26% over a period of time—it may want to tap the country’s retail savings large amounts of which are lying unutilised with banks. Tax-free bonds from an institution backed by the sovereign, at an annual interest rate of 6%, are sure to be lapped up by households. If RBI chooses, it could broaden the definition of the priority sector to include infrastructure which is actually the top priority today given how it can catalyse growth. Since it would need to lend to promoters at affordable rates, for long periods, the DFI must be able to source money at low-enough costs which will enable it to have a decent spread.
More than the resources though, it is the quality of the team that will be critical. It cannot be manned by retired bankers; relevant talent must be recruited, professionals who are experienced and understand the risks related to project finance. This DFI cannot afford to go bankrupt and become another IDBI which was giving loans to all and sundry, partly under political pressure. At the same time, the employees should not fear harassment by the courts, the CVC or the CAG—the government must ensure the legal status of the DFI is such it is not subject to scrutiny by the 3Cs. For the DFI to be a success, we need to pick the right man for the job.