The unquestioned central value of infrastructure expenditure. The budget of February 1, 2021 looks to kickstart the expenditure of Rs 100 trillion national infrastructure pipeline – which is the foundation to achieving a $ 5 trillion GDP economy by 2024-2025. The multiplier effect of infrastructure to connect markets, power industries and businesses and thereby boost demand as well as complement private investment is universally acknowledged.
Launch of NaBID. A bold instrument signaled by the Budget speech is to establish a Development Finance Institution (DFI) called “National Bank for Financing Infrastructure and Development “ (NaBID) through the National Bank for Financing Infrastructure and Development (NaBFID) Bill 2021 to be introduced in this Parliament session. NaBID would be designed to act “as a provider, enabler and catalyst for infrastructure financing and as the principal financial institution and development bank for building and sustaining a supportive ecosystem across the life cycle of infrastructure projects”. It has been indicated that the bill will permit private DFIs as well.
Past Avatar National DFIs. DFIs have globally and historically been used to finance a country’s development and infrastructure requirements, projects of national importance that might not conform to commercial return standards, whose lending could occur at tenors commensurate with long-term development project financing needs and whose funding costs were competitive given their own borrowings were supported by government guarantees. UK’s CDC established in 1948 was the pioneer and thereafter, DFIs were deployed particularly by developing countries who entered the industrial growth late. DFIs were special lending vehicles, which did not fit the mould of regular commercial lenders.
However, in liberalising markets, national DFIs faced neo-classical critiques of resource misallocation and rent seeking in the face of governance concerns as well as competitive pressures. As governments faced fiscal constraints, the model of government guarantees for long-term financing was difficult, and low-cost deposit funding was cornered by banks further limiting financing avenues and so, DFIs were transformed into universal banks. In India, both ICICI and IDBI had originally been set up as DFIs, but were converted into universal banks. This was part of a trend in other developing countries such as Sri Lanka. Should the Budget’s establishment NABFID be seen as harking back to the past ? Given the past experience, is some skepticism warranted?
A Renaissance National DFI: Type of Infrastructure Lending Mandate. On the contrary NABFID represents an opportunity for the Government to design a contemporary, fit-for-purpose DFI whose legal mandate should encompasses three entirely new features, namely (i) an updated scope of infrastructure lending, (ii) access to capital markets for infrastructure lending, and (iii) project life cycle intervention to effectively enable infrastructure development and financing.
Globally, including in Canada and the United States DFIs have established and/or reinvigorated recently. India would therefore, be in line with the G 20 trend. This new wave of national DFIs is also on account of financing social infrastructure- such as education, urban infrastructure and education as well as attaining the Sustainable Development Goals and combatting climate change through investment in green infrastructure.
The acceleration of the Fourth Industrial Revolution following the pandemic, will mean that digital economy infrastructure (automation technologies like drones, artificial intelligence, 5G or blockchain technologies to smart grid and renewable energy infrastructure) are central, and these also require renewed focus on traditional infrastructure such as power and telecom. This will require a long-term, patient financing that conventional sources of funding, including banks are not suited to provide. Given asset-liability mismatches that may arise between short-term deposits and long-term infrastructure financing, requiring banks to fund critical infrastructure could exacerbate existing challenges on non-performing assets. Consequently, DFIs 2.0 will fill the breach as the appropriate vehicle to fund infrastructure projects that require R&D and long term investment.
Tapping Capital Markets and Multilateral Development Banks for Infrastructure Lending. NABFID could catalyst the expansion of the capital markets driven through complementary digital economy reforms currently contemplated in market infrastructure. Deposits are no longer an appropriate source of funding for DFIs given asset-liability mismatch concerns. DFIs should instead be funded by India’s gradually deepening and modernising corporate bond markets. In addition to being able to better attract FDI in capital markets, the NABDFID can also make a concerted effort to tap better local, untapped pools of capital in the form of pension funds, national savings, insurance companies and mutual funds. NABFID should also be able to tap multilateral development banks, including special infrastructure funds through co-financing from developed country bilateral agencies and sovereign government equity support. To this end, the DFI must incorporate the best practice corporate governance principles -including transparency, accountability for corporate performance and ESG, autonomy in lending decisions, independent oversight of risk management and reporting, are particularly crucial given the governance concerns in the Indian financial sector recently. NABFID must set the benchmark for the market and revise perceptions about the Indian market.
Project Cycle Interventions. The new-and-improved DFI must also learn from past pitfalls- a fundamental one was project appraisal and feasibility which itself merits investment. It is a truism that it is easier to find financiers for $ 500 million infrastructure lending than it is to find investors for $ 500,000 for the appraisal, feasibility analysis and preparation needed for an infrastructure project. A reinvigorated DFI must .grant funds for project feasibility studies as part of its mandate. This early investment will obviate later leakages and uncertainties and engender investor confidence.
Even as the nature and scope of infrastructure projects changes, to fund digitally-enabled technologies, NABFID must be reoriented to invest in innovative infrastructure businesses before bringing their infrastructure projects to scale. In general, the cycle of supporting innovative infrastructure businesses goes from the startup stage when angel investors, incubators and crowd funding dominates, through the early to mid-growth stage, to the stage when scale investors support a tried and tested infrastructure business (typically from multilaterals and traditional DFIs and venture capital) to the point where the business can go into the private equity markets. The missing middle is the early to mid-growth stage. By funding innovative infrastructure companies in this phase, the new national DFI can fill a critical funding gap.
This is an opportunity for the NaBID bill to craft a new-age DFI as a key instrument of India’s future growth story.
Authors: Arjun Goswami, Director – Public Policy and Richa Roy, Partner, Cyril Amarchand Mangaldas