Infra needs a development finance institution

By Dipti Lavya Swain and Shruti Sundararajan, HSA Advocates

A development finance institution (DFI), also known as a development bank or a development finance company, is one that provides funding for social development projects. Generally established and owned by governments or charitable institutions, DFIs fund projects that require capital to offset reduced financial returns on investment as they pursue social development objectives. DFIs play a pivotal role in extending credit and boosting economies, especially in developing countries.

Dipti Lavya Swain
HSA Advocates

DFIs in infrastructure

India has several institutions that aid infrastructure development in key sectors such as power, agriculture, housing, foreign trade and the development of industries. However, there is a clear need for an institution which can promptly take up and help core infrastructure projects.

The government is intent on boosting infrastructure development. NITI Aayog (the National Institution for Transforming India, a government think tank,) has estimated that US$4.5 trillion will be needed by 2030 to fund infrastructure, a dream that is still far-off. The ongoing pandemic has underlined the need for infrastructure spending to power economic growth, and an infrastructure-focused DFI will help to kickstart the economy. The government has already put forward over 6,500 infrastructure projects that will require significant funding, putting pressure on the government to establish a DFI for such projects. This need is exacerbated by significant bad debts carried by large financial institutions that have historically lent to the infrastructure sector. The gap between banks’ assets and liabilities, already increased by bad debts will become unsustainable in infrastructure investment, given the long funding periods of such projects.

Shruti Sundararajan
HSA Advocates

Government initiatives

In July 2020, the governor of the Reserve Bank of India stated that the country should not rely only on banks for the funding of infrastructure projects. It seems that the government is considering setting up a new DFI, as quickly as possible, to bridge gaps in long-term infrastructure financing, which will finance social and economic infrastructure projects alike, under the National Infrastructure Pipeline (NIP). The NIP envisages setting up a fund of US$1.4 trillion, supporting 785 projects undertaken by the national and state governments, with additional financing from the private sector.

The appropriate model

There arises the question as to whether the DFI should be government owned, or a public private partnership with the government holding 49%. On the one hand, a government-owned and controlled DFI will ensure that required funding will be forthcoming. However, government control often leads to a risk-averse management, thus defeating the DFI’s purpose. On the other hand, a privatized DFI requires the government to trust the private sector and to treat such a DFI in the same way as a state-owned DFI. Careful contract drafting is required. The government as the minority stakeholder will have to allow the institution to function independently to enable swift decision-making and to ensure the provision of liquidity to projects. Regulatory and compliance requirements should be less onerous resulting in fewer delays to project completions.

To ensure that the DFI, whether government controlled or privatized, is sufficiently capitalized the government should assist it by, for example designating its securities as statutory liquidity ratio eligible, which will persuade banks to subscribe to such securities and fulfil incidental obligations and enable DFIs to sell their securities to banks which will, in turn, earn interest on them and ensure solvency. Another government support measure would be discounted or low cost financing, given that the investment portfolio of the DFI would comprise long-term high-risk project finance. Raising long-term funds at market rates will only increase financing costs for the DFI and may lead to a large number of non-performing assets.

The way forward

DFIs in China, Brazil and Singapore have been successful in both domestic and international markets. In India, a NIP task force is trying to change the financing approaches of banks and financial institutions as well as providing long-term infrastructure funding by creating a DFI with a credit growth of 12-14%. A privatized DFI would seem to be the better model, as at the moment private capital exceeds public funding by a large margin. What is needed is the establishment of standardized and streamlined regulatory frameworks where, despite government participation, decision-making and executive responsibilities rest with the private sector. In any event there should exist a symbiotic relationship, leading to a reliable and efficient DFI that provides project financing and eventually boosts the economy.

Dipti Lavya Swain is a partner and Shruti Sundararajan is an associate.

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