Access to finance
The proposal to improve access to long-term finance assumes that savings are available to be accessed. At a macro level, a predominant part (over 90 per cent) of savings to finance investments in India comes from domestic sources. The household financial savings as a percentage of GDP have been falling in recent years. The revenue deficit of both the central and state governments have been increasing, contributing negatively to savings. So, how much of the problem is availability of finance and how much is access?
No doubt, foreign savings could help finance infrastructure but the aggregate of foreign savings in the economy has to be consistent with sustainable current account deficit, which is around 2 per cent of GDP. Further, if infrastructure projects are funded with foreign currency, they have to assume exchange rate risk, which in turn impacts viability.
Illustration by Binay Sinha
Ideally, long-term contractual savings should finance infrastructure projects since they have long gestation and long life. However, the long-term contractual savings in India are a very small proportion of household savings because the informal sector dominates.
It can be argued that maturity transformation is one of the functions of financial intermediation and, therefore, the paucity of contractual savings should not by itself be considered a serious constraint. This is true. However, the scope and limits to credit enhancement in our context are relevant.
A distinction has to be made between access to finance for infrastructure projects and availability of commercially viable infrastructure projects in an atmosphere of legal, administrative and policy uncertainties, and weak enforcement of contracts.
It is also necessary to distinguish between the financing of housing and financing of infrastructure. Housing markets have unique characteristics and risks associated with them that are different from infrastructure however defined. A defining characteristic of infrastructure is that there is huge and continuing interface with public policy, in particular regulation. Perhaps, an institution, that is now proposed, may not serve both housing and infrastructure sectors.
Sources of finance
Global experience shows that most of the infrastructure in many countries, especially in Asia, has been funded by the government. Alternatively, the DFIs have been used with partial funding by the financial markets or public deposits; but in all cases, strong fiscal support is a dominant feature of financing of infrastructures through DFIs. Banking system
played a role in funding infrastructure in Europe. The bond markets have also financed infrastructure in a few countries, particularly in the United States. In brief, there is no universally recommended method of financing infrastructure and different institutional arrangements do co-exist with varying relative emphasis. Hence, country context is important.
DFIs in India: Pre- and post-reforms
Prominent DFIs in India prior to reforms in the 1990s were IDBI
Most of their business was funding manufacturing and, to some extent, services. Their exposure to infrastructure was minimal. The assumption that their demise caused a vacuum in financing of infrastructure is questionable. In any case, DFIs became unviable in the absence of fiscal support; and inability to compete with large corporations for resources in capital markets.
chose to become banks.
Globally, there are many examples of DFIs transforming into universal Banks.
For housing, National Housing Bank could be considered a DFI. So, there has been a DFI for housing for decades; its performance is not a secret. Perhaps, the new DFI for housing will be different. It is not clear whether the Rural Electric Corporation, Power Finance Corporation and Railway Finance Corporation are to be treated as DFIs dealing with infrastructure. If so, what has been their contribution and performance? What lessons can be learnt from them for the proposed new organisation?
Post-reform, the earliest DFI dedicated to infrastructure financing was established in 1997, namely, the Infrastructure Development Finance Company (IDFC). This was promoted and predominantly funded by the government and the Reserve Bank of India, but structured as a non-government company, and had majority private sector shareholding. It is useful to examine why IDFC also became less developmental and more commercial, and finally evolved into a bank.
India Infrastructure Finance Company Limited (IIFCL) was set up in 2006 as a wholly-owned government company to provide long-term finance to viable infrastructure projects. Its mandate includes credit enhancement. It has several subsidiaries, including one in the UK. It is also useful to assess the progress made by the recently created National Investment and Infrastructure Fund. It was set up by the Government of India in 2015 to provide long-term capital for infrastructure projects.
It is a good idea to learn from experience while establishing new institutions as DFIs, and it is also good to simultaneously examine such proposals in the context of a wider macro economy, commercial viability and standards of governance, in particular conflicts of interests.
The writer is a former governor of RBI