Context: The government plans to set up a Development Finance Institution (DFI) in the next three to four months with a view to mobilise Rs 111 lakh crore required for funding of the ambitious national infrastructure pipeline.
More on news:
- In her last Budget speech, the Finance Minister had proposed to set up DFIs for promoting infrastructure funding.
- The new DFI is expected to build a portfolio of ₹5 trillion in the next three years.
- With the initial capital base of ₹20,000 crore as committed by the government, the new DFI, assuming a leverage of around 7 times, can lend up to ₹1.4 trillion.
- About 7,000 projects have been identified under the National Infrastructure Pipeline (NIP) with projected investment of a whopping Rs 111 lakh crore during 2020-25.
- NIP, a first-of-its-kind initiative to provide world-class infrastructure across the country and improve the quality of life for all citizens, will be crucial for attaining the target of becoming a $5 trillion economy by FY 2025.
- The DFI will have a key developmental role apart from the financing role.
Development Finance Institution
- Development Finance Institutions (DFIs) are specialised development organisations that are usually majority owned by national governments. DFIs invest in private sector projects in low and middle-income countries to promote job creation and sustainable economic growth.
DFIs in India: Background and present status
- During the pre-liberalised era, India had DFIs which were primarily engaged in development of industry in the country.
- In India, the first DFI was operationalised in 1948 with the setting up of the Industrial Finance Corporation (IFCI).
- Subsequently, the Industrial Credit and Investment Corporation of India (ICICI) was set up with the backing of the World Bank in 1955.
- The Industrial Development Bank of India (IDBI) came into existence in 1964 to promote long-term financing for infrastructure projects and industry.
- DFIs in India like IDBI, ICICI and IFCI did play a significant role in aiding industrial development in the past with the best of the resources made available to them.
- After the 1991 reforms, these DFIs had to change their tack due to changed policy stance and business environment.
- Earlier they were getting concessional funding from RBI and the government, which was no longer available in the subsequent years.
- As a consequence, IDBI and ICICI had to convert themselves into universal banks.
- With the conversion of the major DFIs into commercial banks, there were few institutions in the country which could take care of industrial or infrastructure development.
- While these DFIs disappeared, a new set of institutions like IDFC (1997), IIFCL (2006) and more recently, National Investment and Infrastructure Fund (NIIF) (2015) emerged to focus on funding infrastructure.
- While IDFC was converted into a bank (IDFC First Bank), there has not been much of traction in IIFCL lending for the last 10 years nor is NIIF’s contribution significant.
In India, we perhaps failed to review the mandates given to the DFIs in the past with the view to enable them to change course to meet changing development priorities.
Need for DFIs
- Development Financial Institutions (DFIs) are critical intermediaries for channelling long-term finance required for infrastructure and key manufacturing projects for realising higher economic growth.
- Infra financing needs: India needs a development financial institution as infra financing needs patient capital.
- Inadequate and inefficient infrastructure leads to high transaction costs, which in turn stunts an economy’s growth potential.
- Risk averse nature of banks: Banks are currently not suited for lending for long term projects which do not generate any cash for years.
- Deepening the bond market with regard to infrastructure financing is an important matter and there is a need to do something more in order to have a robust bond market for infrastructure financing.
- International examples: Irrespective of the level of development, countries across the world have set up development banks to finance key infrastructure and manufacturing projects.
- For instance, the European Investment Bank (EIB) acts like a DFI for Europe and the German Kreditanstalt für Wiederaufbau (KfW) provides funding to sub-national institutions within Germany.
- Economic slowdown triggered By Covid-19 Pandemic: The Covid-19 pandemic has exacerbated inequality, the poverty gap, unemployment, and the economy’s slowing down.
- Lack of long term finance: Although India has long-term debt market for the government securities and corporate bonds, it is still out of reach of retail investors and unable to meet the large infrastructure financing needs. Most of the corporate bonds are issued for a period of 5-7 years.
- Fulfilling capital needs of DFI: If the new DFI needs to build a portfolio of ₹5 trillion over a period of three years, the capital base needs to be augmented further by three times.
- If it is proposed as 100 per cent government entity, then the government will have to infuse capital from time to time.
- Alternatively, government may allow equity investment by institutions having long term horizon like insurance companies, pension funds to augment the capital, which means the government holding would have to go down.
- The ownership and organisation structure of DFI are critical and require greater clarity as this would have bearing on the functioning, flexibility, governance of the institution and its long-term sustainability.
- Capability of DFI: It is critical to hire experts with good understanding of infrastructure, policies, financing and risk management to work with the institution by offering market-driven compensation package.
- Enabling environment: Achieving a ₹5 trillion portfolio over the next three years requires resources from long-term institutions like insurance companies, pension funds.
- Private players may be reluctant if there are uncertainties as regards government policies, regulations and delays in getting approvals.
- The designing of framework for risk allocation is crucial to attract private participation.
- Attracting long term investments: The government needs to set up institutions and network platforms to reach retail investors and incentivise and structure the bonds/instruments so that they are attracted to invest long-term in those instruments.
- Periodic review: Periodic reviews are necessary to ensure that the DFI remains relevant by taking into account changing priorities of the economy and making consequential adjustments in the role.
Most of the successful development banks around the world have seen that the mandates given to them were reviewed periodically and the fresh mandates were given if the existing ones had lost relevance. For a developing country like India, it is desirable that the new DFI remains viable and sustainable to be able to cater to the long-term development financing requirements.
National Investment and Infrastructure Fund (NIIF)
NIIF, a 40,000 crores fund, was set up in 2015 for funding commercially viable greenfield, brownfield and stalled infrastructure projects.
- 49% by Indian Government
- Rest is to be raised from third-party investors such as sovereign wealth funds, insurance and pension funds, endowments, etc.
Areas of Investment
- Energy, transportation, housing, water, waste management and other infrastructure-related sectors in India.
Funds in NIIF
NIIF currently manages three funds each with its distinctive investment mandate. The funds are registered as Alternative Investment Fund (AIF) with the Securities and Exchange Board of India (SEBI).
- Master Fund: Infrastructure fund primarily investing in sectors such as roads, ports, airports, power etc.
- Fund of Funds: Managed by fund managers who have good track records in infrastructure and associated sectors in India. Some of the sectors of focus include Green Infrastructure, Mid-Income & Affordable Housing, Infrastructure services and allied sectors.
- Strategic Investment Fund: Is registered as an Alternative Investment Fund II under SEBI in India. Its primary focus is on greenfield and brown field investments in the core infrastructure sectors.