Budget must focus on new ways of raising long-term finance for infrastructure development

On February 1, the Finance Minister will be presenting Union Budget 2021-22 (Budget), which is expected to reset the growth projections of the Indian economy, which has been battered by the pandemic.

There is no doubt that Budget will be critical for the resurgence of the Indian economy and adequate support from the Central government for development of the infrastructure sector will remain one of the key focus areas of the Budget.

To keep up with the National Infrastructure Pipeline (NIP) and its targeted completion by 2025, it is expected that the Budget will focus on increasing the capital expenditure towards infrastructure development and availability of long-term financing avenues for the same.

As per the NIP, investment of over ₹111 lakh crore was contemplated for the period 2020-25. However, given the impact of the pandemic the infrastructure investment is likely to be much lower than the NIP plan. Successful completion of the NIP would require tremendous amount of capital inflows and limited availability of capital with financial institutions for such long-term capital investment presents a gloomy picture.

Further, the NIP contemplates that the State governments would be required to contribute approximately 40 per cent of the infrastructure investments in India. Given the severe fiscal deficits faced by the States due to the pandemic, the Centre would need to shoulder more responsibility in relation to raising long term financing for infrastructure development.

In view of the aforesaid background, it becomes even more relevant that the Budget focusses on new means of raising long term capex for infrastructure development.

Beyond conventional financing

The government in the past has taken various steps to improve the availability of long-term financing for infrastructure projects such as Infrastructure Debt Funds, Infrastructure Investment Trust and credit enhancement schemes.

However, given the unprecedented challenges before the economy there is a need to develop the infrastructure bond market for private developers. The existing framework mandates that the institutional investor holds the securities till maturity, which could be relaxed so that the same can be traded in the market and, thereby, generates more interest amongst the investors.

Last year, the government rolled out complete tax exemption for dividends, interest and long-term capital gains earned by SWFs (sovereign wealth funds) and pension funds from investments in specified “infrastructure business”. It was a significant step towards incentivising investment in infrastructure sectors like transport, energy, water, sanitation, telecommunication, and “social and commercial infrastructure” which in turn includes hospitals, tourism, education institutions, affordable housing, and the like.

Notably, the exemption is not automatic, it requires government approval. In addition to the prescribed conditions, the government has the power to prescribe additional conditions at the time of granting the approval that could be case specific. To make this tax relief more effective, the industry expects relaxation of certain conditions which could provide more flexibility to the investor.

Further, policy interventions are required so that the project implementation companies are able to issue bonds to secure funds from the pension/sovereign funds during the construction phase of the projects. For achieving the aforesaid, creation of an institution for credit enhancement is mandatory so that the project companies issuing the bonds can achieve desired credit ratings for the pension/sovereign funds to invest at the project level.

Setting up of development finance institution (DFI) can go a long way in creating a corpus for infrastructure financing in India. DFIs are not new to India and some of the existing banks such as ICICI and IDBI started as DFIs and later got converted into banks. DFIs can focus on raising low-cost foreign funds for long term infrastructure financing.

Based on media reports, it appears that the Central government may announce setting up of a mega DFI by merging few existing financial institutions. However, the structure and the Central government’s support available to such DFI remains to be seen.

Another area which is expected to receive impetus is creation of bad banks to clean up the balance sheets of conventional lenders. The Confederation of the Indian Industries (CII) in its pre-Budget memorandum has also emphasised that the government should take steps to create bad banks to buy out stressed loans.

Way forward

It remains to be seen if the Budget takes into consideration the immediate need to arrange alternative modes of long-term financing for the infrastructure sector. The government will also need to focus on incentivising the private sector adequately to participate in infrastructure development, which is of utmost importance for reviving the economy.

Another area of concern which needs policy intervention is ‘ease of doing business’, given the Central government’s push to ‘Aatmanirbhar Bharat Mission’. It is expected that production-linked incentives will also receive impetus and more sectors would be included under the scheme which would encourage foreign investments into the manufacturing sectors, thus creating more employment and promoting exports.

Leonard Cohen believed that “there is a crack in everything, that’s how the light gets in”. Looking for the silver lining, this pandemic has nudged the government to make a serious effort towards revamping the slowing economy where walking the talk with more focussed strategies would be the key. Therefore, there is a lot to look forward to, the Budget is expected to provide us a peek into the future of economic reforms and direction in which the Indian economy will be headed in (at least) the next five years.

Thaplyal is Partner, and Mukherjee is Principal Associate, Khaitan & Co