The Hindu Business Line : Infrastructure investments — Not needed, yet another financing entity

THE Government has announced yet another entity to take responsibility for financing infrastructure investments. The announcement early this month by the Finance Minister, Mr P. Chidambaram, indicates that a special purpose vehicle (SPV), the India Infrastructure Finance Company Limited (IIFCL), would be set up. It is expected to have government's guarantees of Rs 10,000 crore for borrowings. Fresh annual limits for guarantees by the government will be decided at the beginning of the next fiscal.

The SPV is expected to raise long-term loans, both from domestic and overseas markets. It can also borrow from multilateral institutions, such as the World Bank and the Asian Development Bank. The SPV will be 100 per cent government-owned.

IIFCL will give priority to projects awarded to a private company under public-private partnership through competitive bidding. Similarly, projects that qualify for viability gap funding would also be taken up. It is stated that the SPV will not undertake any project appraisal on its own.

It would consider only those projects that have been approved by a lead bank. In a sense, the SPV will be a refinancing institution. The loan assistance from the SPV would not, however, exceed 20 per cent of the project cost.

IIFCL joins the stable of the many institutions set up to finance infrastructure, such as the Power Finance Corporation, the Railway Finance Corporation and the Tourism Finance Corporation. The restrictions on its functioning — for instance, that it will not appraise any project on its own — do not seem to serve any purpose, except to reduce its staff load and distinguish it from other institutions.

Given the experience of many refinancing institutions, to what extent IIFCL can fulfil its role of a lending institution without undertaking appraisal of projects remains a matter of doubt. It casts a heavy responsibility on the primary lending institution, whose quality of appraisal becomes critical.

It may be recalled that the Finance Minister had himself set up the Infrastructure Development Finance Corporation (IDFC) in his earlier tenure at North Block. The IDFC has its equity subscribed to by the Government and the RBI. It recently had a successful initial public offering as well. True, it has had teething troubles, allegedly as a result of shortage of eligible projects — a rather intriguing observation given the general shortage of infrastructure. Hopefully, IDFC will have a better record of success under the new leadership. But the question is what the new SPV will achieve beyond what IDFC has been able to. What special features entitle it to make a claim that it is a new efficient window for infrastructure financing?

Many observers have noted that India has a weakness for creating new entities whenever it is faced by major problems of substance that relate to structure. The difficulty in financing infrastructure is not because of dearth of institutions, but because of inherent defects in the infrastructure policy.

In spite of this, banks themselves have been funding infrastructure projects quite liberally. The increase in liquidity in the financial system as a whole has enabled banks to consider more infrastructure financing. Probably, the need for an SPV is felt because banks themselves may be unable to handle mega projects.

Partly, this problem arises because of the limited net-worth of banks. This, in virtue of current exposure limits, restricts the banks' capacity to finance large projects. To remedy this, the new SPV should have sufficiently large equity to support its exposures to major projects. I see no mention of this aspect in the published information on the new SPV. To my mind, the SPV is no different from the IDFC, except that it does not allow itself to appraise projects. Its access to resources will be the same as that of the IDFC's. In this context, it needs to be reiterated that the current failures in infrastructure financing partly reflect the lack of an adequate risk-taking appetite on the parts of managements of banks and the financial institutions. This, in turn, reflects the poor state of policy regarding the levy of user-charges, be it in power, or water supply, or airlines.

Until the Government bites the bullet and lets enterprises in the infrastructure sector charge rates that will make them viable, financing will be difficult, however many new institutions we create.

No amount of financial gimmickry in the form of new financial entities will help solve the basic problem, which arises from lack of political will to charge for the services.

It is worth recalling that the exhaustive report on India's infrastructure presented by a Committee headed by Mr Rakesh Mohan in 1998 had gone into these issues in great detail. It had pointed out the basic infirmity in infrastructure funding. However, it made a recommendation to set up the IDFC, which found eager acceptance at the Finance Ministry. But the problems of viability gap remain.

Unless the policy-makers solve this problem, funding for infrastructure will not materialise even if we create new entities for financing.

It is worth noting that the Rakesh Mohan Committee report had itself pointed out how the Chinese have handled the problem. They had set up the China Development Bank based on Japan's experience in establishing a Development Bank of Japan.

The State Development Bank of China (SDB) has been responsible for at least part-funding mega projects, such as the multi-million dollar Three Gorges Hydel Project, the Beijing, Kowloon Railway and the $3.5-billion Daya Bay Nuclear Power Project in southern China. The Chinese SDB has been a remarkable success in infrastructure financing and its example deserves to be followed rather than create too many institutions. The IDFC should be our SDB.

If the proposed SPV (IIFCL) has to develop into a major infrastructure funding agency on the lines of SDB of China and the Development Bank of Japan, it seems important to emphasise the quality of its top management, including nurturing and ensuring the willingness to take risks.

In this sector, like in most project lending, the fear of the unknown is bound to inhibit decision-making, especially faced by the memory of such fiascos as Dabhol.

There is also the crucial issue of raising equity for infrastructure projects that will have to be implemented by separate entities. Whether the new SPV will be authorised to take equity along with other equity investors in the infrastructure projects it finances is not clear. It is not also clear how the SPV can contribute to equity in infrastructure projects.

It is important to note that the cost structure of infrastructure projects will, in turn, depend on their equity debt structure. The Government needs to examine how to empower and enable the SPV to contribute to the equity of infrastructure project entities it finances with debt.

In conclusion, I would like to suggest that instead of experimenting with a new SPV, the Government can devote its resources and energy to strengthening the existing entity, IDFC, which can undertake the job assigned to IIFCL with such modification as may be necessary. It is wrong to assume that a new institution per se will solve the infirmities which IDFC faces. Far better will it be to "mend" the IDFC than to create new institutions, which will have their own teething troubles. A new broom does not necessarily make for a cleaner home.

Finally, a thought about the SPV structure. SPVs have an advantage only if they confer any special benefit either in terms of accountability or statutory limitations. An SPV fully-owned by Government, as is now proposed, will be subject to all the constitutional limitations, such as are imposed by Article (12). It will also have the character of a State involving restrictions on its right to function as a corporate entity.

The SPV as proposed cannot also escape the constraints of investigative agencies, such as CBI and CVC, which can be limiting in terms of entrepreneurial initiatives. So, what does the SPV contribute, in terms of special features, which IDFC does not have?

Maybe, the SPV as proposed is designed to accommodate the concept put forward by the Planning Commission Deputy Chairman, Mr Montek Singh Ahluwalia, to utilise India's forex reserves for infrastructure. That purpose can also be served equally well by IDFC, if only the Government decides on the basic principle of using the RBI's forex reserves for India's infrastructure development. But the proposal, as now visualised, throws no light on this idea.

To sum up, the proposed new SPV for infrastructure is a gimmick that needs to be scrapped before it consumes too much resources and attention at the expense of genuine infrastructure needs. There are more pressing needs in terms of policy gaps, which need to be addressed in the area of infrastructure. Yet another institution is bound to clutter the landscape rather than help build vitally needed facilities.

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Long-distance bonanza

For a win-win business plan

Infrastructure investments — Not needed, yet another financing entity

The Volcker inquiry saga

Turning to faith to find the missing daughters

Peter Drucker

The grand old man of management

Perils of parallel processing

Ombudsman Scheme

Fuel efficiency