At a recent meeting between the Finance Minister, Mr Pranab Mukherjee, chairman of public sector banks and officials from the Reserve Bank of India, the latter had mooted the idea of allowing insurance and pension funds to invest in the infrastructure sector.

Reserve Bank Deputy Governor, Mr. K. C. Chakraborty had observed that commercial bank loans for road, port, airport and power sector projects were at levels which could not be increased much further.

This is because infrastructure projects have a long gestation period, while commercial bank funds are typically for a shorter duration. Hence, there is a mismatch between funds available with commercial banks and the period of loans required by infrastructure companies. On the other hand, insurance and pension funds have long-term funds running into 20 or 30 years. Therefore, they can ideally offer long-term loans for infrastructure projects. However, government policy does not often allow investment of such funds in infrastructure projects.

NO LONG-TERM FINANCE

Indeed, the tenure mismatch has been a major problem not only for banks and for companies engaged in infrastructure sectors. This problem has dogged the entire corporate sector. In the absence of an effective debt market in the country, corporate investment managers have faced a vacuum between the equity market, on one hand, and the short-term commercial bank loans, on the other. Equity market provides risk capital at a certain price. The equity capital raised by companies will have to be serviced with dividend and capital appreciation.

A higher equity base will become immensely costly in terms of both dividend payments or in terms of capital appreciation. As you expand your equity base, the dividend liability will skyrocket and capital appreciation will be very, very limited. As number of equity shares increase, their individual price goes down or remains stable, or at best does appreciate little.

The corporate sector's need for long-term funds for project implementation was earlier met by the three development finance institutions which have mutated in course of reforms and liberalisation of the financial sector — Industrial Development Bank of India (IDBI), Industrial Credit and Investment Corporation of India (ICICI) and the Industrial Finance Corporation of India (IFCI). These were conceived as development finance banks and provided long-term loans to companies. In the wake of financial sector reforms and invasion of the idea of “universal banking”, two of the Development Finance Institutions (DFIs) were allowed to undertake commercial banking. In due course, they metamorphosed into full-fledged commercials only and the DFI role vanished altogether. We are, thus, left with IDBI Bank and ICICI Bank but no DFI. The third one namely, IFCI ran into the problem of non-performing assets and total mismanagement.

Once again, it has ended up as a non-performing corporation itself. A fourth one namely, the Industrial Reconstruction Bank of India, a DFI for nursing sick units back to health, had long succumbed to the illness it was supposed to cure. Thus we are left with a situation where development finance for corporates by way of long term debt is absent in the country. Many proposals have been mooted. The predominant idea was to develop a corporate bonds market which has yet to happen.

FOR NEW INSTRUMENTS

The suggestion at the Finance Minister's meeting to allow tax-free infrastructure bonds is only another form of a corporate bond instrument marked exclusively for infrastructure projects. At any rate, why should such a debt market be limited to the infrastructure sector. What about funding projects for creation of capacity in mining and manufacturing sectors if India wants to be a major manufacturing hub competing with China's giant size manufacturing capabilities? We need such new avenues for mobilisation of investible resources. India's expanding industrial economy needs to have access to newer financial instruments than only equity capital and loans from commercial banks.

In addition, retail investors are also looking at placing their funds in a variety of instruments, and not restricting themselves to commercial banks deposits and indirectly investing in equity markets through mutual funds. A vibrant debt market is essential for an expanding economy. Maybe, we can again resuscitate the development finance institutions.

The problem is that earlier the DFIs asked for low-interest-bearing loans for onward lending to projects. They qualified for the statutory liquidity ratio (SLR) bonds and banks were asked to place their funds. These arrangements could not be reinstituted again. Even the government now borrows at higher rates of interest. Hence a demand for low interest funds is a near-impossibility in these days of high interest rates. Any institution must now learn to work with wafer thin margins by improving operational efficiency.

(The author was formerly with FICCI.)

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