Go beyond setting up a development finance institution

The National Infrastructure Pipeline (NIP), which drew up a road map for investment of ₹102 trillion covering 6,835 projects (now increased to 7,400) over 2020-2025 , was considered over-ambitious from the start and has largely been a non-starter. India’s private sector has lacked both the resources to support the NIP and willingness to assume the imponderable risks involved. The government was unable to put in sufficient funds, and the economic stress caused by the covid pandemic worsened the scenario. Private participation has been in decline, despite several measures taken by the Centre in recent years to promote it, from inviting foreign investment and streamlining regulations to introducing innovative finance mechanisms like infrastructure investment trusts (InvITs), debt funds (IDFs) and our National Investment and Infrastructure Fund (NIIF).

To facilitate private investment and make debt finance available, it was imperative for the government to adopt another approach. Typically, infrastructure projects raise 45-80% of their funding requirements from commercial banks. But banks lack the domain expertise needed to understand the nuances of financing and monitoring a diverse range of highly complex projects. This circumstance explained the call for a development finance institutions (DFIs) that could mobilize funds for project lending.

In the budget for 2021-22, the government has proposed the setting up of a DFI for the purpose. It should, however, exercise great care in how it is structured and operationalized. Indeed, there are learnings from the experience of India Infrastructure Finance Company Ltd (IIFCL), which was set up with the same intent but failed to make a worthwhile contribution. Being a government firm, it lacked the autonomy to act as a vibrant financial institution or spur infrastructure investment. Also remember that yesteryear DFIs like IDBI racked up non-performing assets (NPAs) and were converted into regular banks.

For a DFI to be successful, it should be set up with an ownership and management structure like that of HDFC and ICICI. The strength of a DFI lies in its domain expertise, and it may therefore be advisable to create sector-specific DFIs .Further, these should also be allowed to raise medium- to long-term deposits, akin to commercial banks.

Infrastructure finance companies could be asked to transition into infrastructure banks over a period of 1-3 years, which would also help them overcome their asset-liability mismatches, as was recommended by the Usha Thorat Committee. The proposed DFI can use the network of such infrastructure banks to finance or refinance projects.

Equally important for success is the broadening and deepening of India’s corporate debt market, which is just 16% of gross domestic product, compared with 46% in Malaysia and 73% in South Korea. The budget proposal of an institutional framework to purchase investment-grade bonds may help in achieving the objective of a robust market for corporate debt. This is especially important because while infrastructure trusts and funds have failed to help much, even credit enhancement products and the wider participation of pension funds and insurance companies have not made a worthwhile impact. But for a vibrant bond market to emerge, the country needs wide-ranging legal, regulatory and institutional reforms, most of which have been under debate for a long time now.

It would also be helpful to bear in mind that funding of projects is necessary but not the only condition for the rapid development of infrastructure. Investors are concerned about procedural and legal hassles in land acquisition and environmental clearances, defaults in payments by concessionaires, and various contractual and regulatory uncertainties. As per a recent report, 1,687 large infrastructure projects have suffered cost overruns in aggregate of about 20%, and out of these, 447 are delayed for more than one year. Sickness even before a project is commissioned for use remains a problem.

This suggests that apart from setting up a DFI, the government should institutionalize mechanisms for time-bound approvals and clearances, coordination between the central and state governments (and their agencies), enforcement of contracts, and resolution of disputes.

Public-private partnerships (PPPs) have been an important vehicle for infrastructure development. As of March 2020, a total of 1,824 such projects worth $327 billion were under implementation. Yet, the experience of PPPs so far has also been far from satisfactory. For these to fulfil their potential, an effective dispute resolution mechanism is needed, which would require a legal enactment or a workable administrative arrangement. PPP models like the toll-operate-transfer (ToT) and hybrid annuity model (HAM) have helped India build highways, as they enable effective risk-sharing and offer attractive returns by keeping developmental and operational risks apart. These should be encouraged in other areas of infrastructure as well. A DFI should help in creating innovative vehicles and products that suit the distinctive characteristics of various projects.

Setting up a DFI is undoubtedly important for infrastructure development. But the NIP may remain a pipe dream unless supported by a multi-pronged strategy that addresses gaps in the entire value chain of investment promotion and infrastructure creation. Financing is only one link in this chain.

Ashok Haldia is former managing director, PTC India Financial Services Ltd.