NaBFID-One more infrastructure-finance institution takes wing

Parliament passed the National Bank for Financing Infrastructure and Development or NaBFID Bill, 2021, giving birth to a new infrastructure financing institution somewhat on the lines of the erstwhile Industrial Development Bank of India (IDBI). IDBI, which was created through a similar Act in Nehruvian times (in 1964), was converted into a commercial bank by the Vajpayee government through repeal of the 1964 Act in 2003—it was felt India had progressed in reforming the financial sector, capital markets were more mature and had acquired risk appetite, and the attention must shift to bond market development. The creation of the NaBFID for raising long-term resources for funding infrastructure projects therefore marks failure to develop a vibrant bond market. Ironically, the institution itself is tasked to fulfil this objective!

Besides IDBI, other development finance institutions (DFIs) were also created in specialised spaces, e.g., former ICICI, IFCI, amongst others. Not just India, DFIs were also set up in Europe, Japan, the US, other Asian countries in the post-World War II period to build or rebuild infrastructure; most countries channelled long-term household savings (e.g. pension, insurance, postal, etc) for financing such projects; once basic infrastructures were built and private markets developed, most DFIs were either wound up or adapted. India then had low saving rates, underdeveloped financial sector, foreign exchange constraint—features that necessitated government guarantees, capital commitments including from RBI along with direct and indirect central bank financing to meet these needs. Bank nationalisation (1969) immensely spread banking services and access, deposit mobilization and lifted saving rates. But these increasingly financed government deficits enabled by financial repression (viz.
high SLR, CRR, administered interest rates, selective credit controls) to reserve resources and keep costs low, bringing banks into the overall public balance sheet fold for national development. These features, plus unrestrained monetary expansion resulting there from, coupled with other factors eventually culminated in the 1991 BoP crisis.

This was the backdrop of financial sector reforms thereafter. The blueprints drawn by Narasimham, Khan committees, amongst others, focused as much upon the role, structure, ownership, restrictions and deregulation of financial institutions as upon the monetary-fiscal interfaces and associated macroeconomic implications with requisite reforms for their rectification. In the scheme of things, there was recognition a lot had changed since the sixties where DFIs were concerned; there was universal agreement to gradually phase these out, cede way to market forces and sources of finance—DFIs either were to transform into banks or close if any couldn’t.

The recreation of a DFI, the NaBFID, does not transpire merely in this longer historical context but also within more contemporary developments: inter alia, the challenge of long-term funding for one of the riskiest activities worldwide (infrastructure), sporadic emergence and collapse of private sector participation, failure of private infrastructure markets to develop, depleted resources for public investment, and inabilities of successive governments to significantly free resources, all of which justify its creation.

That said, the NaBFID bill, whose rules are not yet framed nor notified, raises a number of fiscal and monetary concerns.

Monetary
The NaBFID Act permits 90-day, secured borrowing from RBI (repayable on demand/ expiry); and up to five years against bills of exchange or promissory notes. This no doubt increases the fiscal-monetary interface, setting back to an extent the deliberated separation of central bank and government balance sheets as part of financial sector reforms. Significant ones in this context were ending automatic monetisation (1997); phasing out RBI refinancing of various entities; financial repression, viz. graduated reduction of SLR, CRR, administered interest rates to align with market ones, selective credit controls; institution of fiscal rules; rationalizing profit transfers from RBI; and separation of debt office from RBI after fulfilment of pre-conditions (still to be achieved).

The reason why automatic monetisation of deficits and RBI refinancing were stopped was to restore order, gain control over money supply and hence, inflation. Note that Loans & Advances to extant DFIs (e.g. IDBI), Bills purchased and discounted to government, directly impacted the monetary base; such sources of money creation ended in 1997 for government and 2002 in the case of IDBI (transferred to government).

Now, RBI no longer targets money supply, but directly inflation instead, but it is not as though it ignores monetary aggregates. While the central bank can always adjust reserve money constituents, there is concern about displacement of the private sector that would add to the market crowding-out cause by persistently high government borrowings. Hopefully, the NaBFID rules will shed clarity on financing volumes, limits, and safeguards against refinancing and rollovers. But the larger public sector borrowing will have to be minded, especially with resurfacing of elements of financial repression in FY20, or before the Covid shock.

Fiscal
Wholly government-owned at creation and with minimum 26% holding over time, the ambit of NaBFID’s activities permit wide-ranging guarantees: guaranteeing of any liabilities of its own subsidiaries, joint ventures, branches and suchlike arrangements; issue of guarantees, letters of comfort, or letters of credit for loans/credit arrangements or debentures/bonds issued by any financial institution funding infrastructure projects in India; and central government guarantee of NaBFID’s bonds, debentures, loans and borrowings from multilateral institutions, sovereign wealth funds, and other foreign institutions.

The potential creation of contingent liabilities and therefore, further debt accumulation raises fiscal concerns. The FRBM Act explicitly limits additional guarantees with respect to any loan on security of the Consolidated Fund of India over 0.5% of GDP in any financial year. The contingent liability-GDP ratio was 2.4% in FY20 and FY21 revised estimate at 3.1%. The passage of NaBFID Act at the budget session’s end raises questions about extent of guarantees. There’s been silence about FRBM Act amendment or modification since, making the vacuum on fiscal rules and absence of a credible, medium-term redemption plan for gradual reduction of public debt that’s estimated touching 90% of GDP in March 2021.

Looking ahead
The government conceives massive scale-up in infrastructure investment—Rs 111 trillion spread out to FY26, against which NaBFID’s capital of Rs 200 billion and leverage to Rs 3 trillion is grossly inadequate. If competitive pricing, i.e. cheaper funds, are to be raised, government guarantee is necessary; else, the risk is too high. The role of sovereign guarantees assume greater significance in the light of two institutional failures, viz. IDFC (setup in 1997) and IIFCL (created in 2006 and likely to merge with NaBFID); these were both set up to finance and mobilise capital for private infrastructure development. This shadow looms over the latest such institution, whose success visibly depends upon government guarantees.

Further, in spite of government guarantee, cost of funds may not come down significantly as long as the larger public sector, including central and state governments, continues to corner most national financial savings. Given the gigantic infrastructure investment ambitions, NaBFID should not end up accessing a larger quantum of funds directly from RBI. We have just seen how the central bank was constrained to commit its balance sheet via the new G-SaP bond acquisition tool for a comfortable government borrowing programme this year. One should worry if NaBFID turns out to be another source of perennial leakage that was successfully blocked two decades back.

The author is New Delhi-based economist