The government of India is setting in motion plans to establish a new Development Finance Institution (DFI) to bridge the gap in long-term infrastructure sector finance. This move is part of the government’s broader effort to boost economic growth and improve living standards for its citizens.
Development Finance Institution: Purpose and Potential
The proposed DFI is intended to fund both social and economic infrastructure projects identified under the National Infrastructure Pipeline (NIP). In April 2020, the government unveiled the final report on NIP for the period from 2019 to 2025, identifying projects worth a combined investment of Rs. 111 lakh crore across roads, railways, energy, and urban sectors. The task force in charge of NIP, led by Economic Affairs Secretary Atanu Chakraborty, aims to provide a forward outlook on infrastructure projects. These undertakings are hoped to generate jobs, enhance ease of living, and ensure equitable access to infrastructure, contributing to an inclusive growth model.
The Government’s Role in DFI
The DFI could take one of two potential forms. It could either be promoted by the government or assigned a private-sector character, with the government limiting its holding to 49%. Owning the DFI fully presents significant advantages for the government, the most salient being fundraising capacity. In this arrangement, DFI securities could be deemed Statutory Liquidity Ratio (SLR) eligible. This would encourage banks to subscribe to securities issued by the DFI, in turn meeting their SLR obligations stipulated by the Reserve Bank of India (RBI), which mandates banks to reserve 18% of their net demand and time liabilities towards the SLR.
Concerns Regarding the Management of DFI
Potential issues may arise if the DFI is under the complete control of the government. For example, the senior management of the DFI could be subject to scrutiny from investigative agencies such as the Central Bureau of Investigation (CBI), Comptroller and Auditor General (CAG), and Central Vigilance Commission (CVC). Conversely, if the DFI adopts a private-sector character, it will require the government’s trust and a certain degree of distance from the DFI’s affairs. This would allow the institution to carry out projects aimed at enhancing citizens’ quality of life without fear of potential repercussions from the CBI, CVC, or CAG.
The Challenges of Infrastructure Financing
Infrastructure financing currently faces several challenges. Banks are failing to provide long-term finance to infrastructure projects, leading to a funding gap. Furthermore, there is a notable asset/liability management mismatch in India due to banks borrowing funds with a maturity of fewer than 5 years, primarily due to the lack of a robust bond market. Consequently, banks lend to projects with a maturity of around 20 years using funds of 2-year maturity, leading to a mismatch between the maturities of assets and liabilities.
Role of Development Finance Institutions
DFIs are crucial in providing long-term credit for capital-intensive investments that span over long periods and yield lower returns. Examples of these investments include urban infrastructure, mining and heavy industry, and irrigation systems. Additionally, DFIs often lend at low and stable interest rates to promote long-term investments with substantial social benefits. It’s worth noting that DFIs differ from commercial banks, which gather short- to medium-term deposits and lend for similar maturities to avoid maturity mismatch.
Development Finance Institutions in India
India has a long history of development banking institutions. However, in recent years, some of these institutions like ICICI, IDBI, and IDFC have transitioned into universal banks due to the lack of low-cost funding for long-term projects. The current landscape of DFIs in India is predominantly sector-specific, with organizations such as the Rural Electrification Corp Ltd (REC) for the power sector, National Bank for Agriculture and Rural Development (NABARD) for the agriculture sector, and Indian Railway Finance Corp for rail infrastructure.
The Need for DFI
For India to sustain a growth rate of 8-10% continuously, credit growth for infrastructure needs to be between 12-14%. Given the scale of investment required and the need for long-term funds, a large DFI is seen as a positive step forward. A DFI can provide long-term finance for social and economic infrastructure more effectively compared to banks. However, DFIs also involve higher risks than the traditional financial system might be able to bear.
Last Modified: February 9, 2024