The challenge of long-term finance
The 2008 financial crash is understood to have been caused by a combination of greedy loan-pushing bankers, carefree NINJA borrowers (or No Income, No Job or Assets), negligent rating agencies, hungry investors (for yield), and indulgent regulators. Nobody so far (outside of Iceland) has gone to jail for misdeeds in a crisis that unleashed such a large-scale humanitarian cost. In a way, it was nobody’s fault or everybody’s fault.
One aspect of the crisis which came in for much scrutiny post-Lehman was the practice of using short-term borrowing for funding long-term assets. Non-bank finance companies used a leverage of 50 or 100 times their equity base to borrow overnight money-market funds to fund long-term assets. These, in turn, were securitized and units were sold to gullible investors who became more and more remote to the origination of the loan asset, or its end-use. This scheme, of course, unravelled spectacularly when short-term lenders called in their funds, and assets could not be liquidated at short notice. Credit markets froze and panic selling led to crashing prices for securities, and rapidly shrinking balance sheets.
New regulation post-Lehman has put a ceiling on leverage. Also, banks cannot sell off their loan books completely; they must have some skin in the game. But that gross asset-liability mismatch will be a reminder of the havoc it can unleash. Curiously, in the case of India’s government finances, we have the obverse situation. The state borrows long-term funds to pay for short-term expenditure. The Central government typically borrows between Rs5-6 trillion annually, mostly by issuing long bonds of 20 or 30 years’ maturity. This pays for the fiscal deficit, and also any bond repayments that may arise during the year. But the money raised through sovereign borrowing is mostly for current expenditure, not to build long-term assets. Of course, government accounting does not permit classification into current and capital expense. However, the fact is that there is no matching of maturity of funding source and its use.
This is very relevant when we discuss the challenge of financing India’s infrastructure. For the past decade or more, we have shouted from the rooftops that India needs at least $1 trillion to build its infrastructure. Various funding models were worked out, most prominently the public-private partnership (PPP) model. Except for telecom, and partly in the power sector, most funding has to come from public sources. Much is made of the fact that India has a high savings rate and a young demography which can meet the funding needs (never mind that two-thirds of national savings are absorbed by the non-financial ends of land and gold). The current state of India’s infrastructure push is a sobering reality. No doubt, the savings of low oil prices gave us extra fiscal space to budget nearly Rs4 trillion for infrastructure. But most PPP projects are stalled. Many have turned into stressed assets for lenders who happen to be mostly public sector banks. In roads and other spheres, the PPP is being replaced by old-fashioned EPC (engineering, procurement and construction) contracts that are progressing much better.
Let’s examine four alternative ways of meeting this challenge. Firstly, the long-term bond market is simply not deep or liquid enough. In the mid-1990s, when ICICI (then not a commercial bank) sold deep discount bonds, their call option was used to extinguish them much before they matured. Konkan Railway Corporation bonds did sell, but had very little secondary market activity. The corporate bond market is burdened by the overhang of large government borrowing. Beyond bonds, even if the entire assets of the Life Insurance Corporation and pension and provident funds were used, it would barely cover 15% of the total requirement. This is because India’s insurance and pension market is still under-penetrated.
Secondly, the government’s own borrowing capacity is constrained by the requirements of fiscal discipline. Much of the annual borrowing is in any case spoken for, leaving little room for an aggressive infrastructure push. Can we cross a mental lakshman rekha and sell sovereign dollar bonds? Even debt-strapped and junk-rated Argentina could sell 100-year bonds recently. Surely, there would be great appetite for India’s dollar bonds. But we have never sold any, and it can have repercussions on domestic interest rates and policy manoeuvrability.
Thirdly, can we not negotiate a multilateral deal with global institutions? We are already the largest borrower from the World Bank, and have fund commitments from the Japan International Cooperation Agency as well as the Asian Development Bank. Alas, these fall short of our funding requirement. Also, they have to deal with their own asset liability mismatch issues.
Lastly, we could explore bilateral deal options, say, with China. 1% of China’s foreign exchange stock annually, as capital inflow into India, can wipe out the bilateral trade deficit. Recently, China and Brazil have jointly set up a $20 billion fund for the latter’s infrastructure. This arrangement works because China also happens to be a major importer of Brazil’s food and agricultural production. In India’s case, the chance of success is more limited. Other countries which are flush with pension or sovereign funds could be potential partners.
The inescapable conclusion is that India’s challenge of finding long-term funds is far too ambitious, and perhaps a more realistic target of $500 billion is more achievable. The way to attain that target would be in small steps, with necessary tweaks in policies and institutions.
Ajit Ranade is chief economist at Aditya Birla Group.
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