The investment division of the finance ministry has finally approved setting up of the National Investment and Infrastructure Fund (NIIF), initially proposed in the last Union Budget.

The Fund is likely to be operational from the end of this year. Finance Minister Arun Jaitley in his recent visit to Singapore and Hong Kong pitched to the pension and wealth funds there to invest in the NIIF, touted to be India’s own version of a sovereign wealth fund (SWF).

The Fund will receive an initial allocation of ₹20,000 crore as seed money, which, in turn, will be used to lend equity/quasi-equity/debt support to commercially viable green-field and brown-field infrastructure projects, including stalled ones.

The Fund is also mandated to provide equity/quasi-equity support to non-banking finance companies and financial institutions involved in infrastructure financing, and to nationally important projects in the core sector.

The sovereign fund The NIIF will be established as one or more alternate investment funds (AIFs), regulated by the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012, and classified under Categories I, II and III, each category attracting differential tax treatment under provisions of the Income Tax Act.

With such a paltry budgetary allocation, and financing model hinging too heavily on the Fund’s ability to attract external long-term finance, one wonders how such a complex objective function can be sustainably achieved.

The basic motivation of creating this new entity is to bridge the glaring infrastructure financing deficit in India. India’s current infrastructure spending is around 4.5 per cent of GDP.

This is relatively lower than other emerging market economies. Industry body PHDCCI and Crisil Ratings estimate that Indian infra would need at least ₹26 lakh crore over the next five years considering the government’s ambitious plans such as Make in India, Smart Cities and Digital India.

It is projected that 70 per cent of this required amount is likely to be debt financed, with banks being the largest source of finance, while 14 per cent will come from external commercial borrowings (ECBs). The rest is likely to be financed by bonds.

It is clear that bulk of the financing needs in the infrastructure sector shall be catered to by commercial banks. This will put considerable strain on their balance sheet due to the mismatch between maturity tenures of deposits and loans disbursed to infrastructure projects, which have long gestation periods.

Going forward, it may be difficult for the banks to play the same supportive role, particularly considering that stressed loans is are growing.

As of March 2015, stressed loans account for 14 per cent of gross advances ($161 billion). Significantly, 30 percent of the growth in stressed loans are in the infrastructure sector, particularly, power.

Tall order The NIIF is expected to bridge the existing financing gap, and ease the pressure on banking. The plan to do so, however, rests on some naïve and unclear assumptions.

For example, to source funds, the government is looking to primarily tap into strategic anchor partners such as foreign SWFs, pension funds, multilateral and bilateral investors which represent a potential source of large, stable, and long-term finance.

Estimates from the Sovereign Wealth Fund Institute show that, as of August 2015, the assets under management (AUM) of 15 of the largest sovereign wealth and pension funds amount to around $6.1 trillion. The government believes its participation (49 per cent in each entity set up as an AIF) would project NIIF as a sovereign fund, attracting overseas investments.

Guarantee of sovereign participation in NIIF may, in the short-run, attract overseas participation. The recently announced UAE-India Infrastructure Investment Fund with a corpus of $75 billion may be a case in point.

Even as we see to what extent the corpus is co-invested in NIIF, the government cannot ignore the long-run conditions essential to sustain participation of foreign SWFs in such a Fund.

Foreign SWFs, mostly guided by strategic and commercial objectives, are unlikely to co-invest in the Fund unless India’s growth potential remains robust, and unless forward-looking concomitant reforms are initiated, particularly the ones that can remove impediments for infrastructure development in the country.

All the ambitious projects announced by the government are land- and infrastructure-intensive, and so passage of the revised land acquisition Bill is central to kick-start the investment cycle.

The political deadlock on the Bill is projecting a negative message to the rest of the world, including the SWFs, which arguably shall be keen to invest in a more stable business environment, (and) not where it faces policy paralysis.

Unless the government corrects the basic underlying conditions that would ensure a decent return on their investments, we are unlikely to see big-ticket investments in NIIF from foreign SWFs.

Watch the economy There are other issues as well. For each entity set up as an AIF, fixing the government’s share at 49 per cent, while making it non-obligatory for partners to infuse similar funds to maintain their equity holdings, seems problematic.

This may mean that there may be increased pressure on cash-surplus PSUs to part-finance different AIFs, limiting their own investment or expansion plans. As has been envisaged, participation of central PSUs, domestic pension and provident funds, and national small savings fund could easily take the sovereign and quasi-sovereign contribution in the Fund to three-fourths or above, putting considerable strain on scarce fiscal resources.

Around the world, SWFs are normally established out of trade surpluses, official foreign currency operations, and fiscal surpluses. None of these conditions is favourable for India and, therefore, raises doubts about the long-run capability of NIIF to fulfil the objectives for which it is being created.

The success of NIIF will hinge upon the extent to which it is able to rope in overseas strategic institutional partners. But that, in turn, will depend on India’s growth story.

(Nandy is assistant professor and Sur a Fellow Programme in Management student in IIM Ranchi)

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