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HONG KONG/LONDON: India needs a solution to a $1.5 trillion-plus puzzle. That's what it will need to invest in infrastructure over the next decade if it is to have any hope of achieving its aspiration of 10 percent GDP growth. The government and banks, India's traditional sources of infrastructure funding, won't be able to carry that load on their own. Financial liberalisation, something the country has hitherto shied away from, could help fill the gap.
Poor infrastructure is one of the main things holding India back. Poor logistics cause waste equivalent to 5 percent of GDP, according to McKinsey. Roads such as the "golden quadrilateral" -- joining the country's biggest four conurbations -- are being laid down, but not rapidly enough. No wonder the roads minister was shifted in a cabinet reshuffle earlier this month. An estimated one-third of all fresh produce spoils before it reaches the market, and most of the country's railways predate independence in 1947. There are chronic electricity shortages in most states. And then there are the heaving cities, suffering from poor sanitation and virtually bereft of mass public transport.
The government and its planners see the problem. The ongoing five-year plan called for $500 billion of infrastructure investment. The next, which runs until 2017, will argue for $1 trillion. With India's public debt at over 60 percent of GDP, and a current account deficit touching 4 percent, plans to put up half of that from public finances seem less than ideal.
Foreign direct investment can play only a small role. FDI was $24 billion in 2010, according to the International Monetary Fund, only a quarter the amount China attracted, and not all of India's inflows went to infrastructure. Foreign investors are still largely deterred from building projects because of uncertainty over policy logjams and ever-present corruption.
Don't bank on it
Meanwhile, India's banks are also financially constrained. Part of the problem is that the banking industry -- much of which is state-controlled -- needs more capital to keep up with India's rapid growth. To finance real GDP growth of 10 percent, given inflation of say 5 percent (which is less than India currently experiences), loans probably need to increase by something over 20 percent a year. Of course, the banks can go to the market and raise the necessary capital -- indeed, a rash of equity issues is expected this year. But if the state wishes to maintain its stakes in the banks, it will need to dig into its own, bare pockets. Even if it can find the cash this year, it may need to see itself diluted in the longer term -- and that will require changes to the law, a tricky proposition given that India's corrupt politicians see state banks as their playthings.
It would also be easier to finance lending growth if the banking industry was opened up to more new entrants. Foreign banks want a bigger slice of the cake, but they have to beg to get every single extra branch. India's non-banks are also lobbying to be allowed to get into the market. Liberalisation may happen -- the authorities are examining the issue -- but the existing players have a strong vested interest in preventing more competition.
Even if these issues are dealt with, banking is not the ideal solution for infrastructure financing. Loans need to be long-term, say 15-20 years. Yet banks' liabilities, such as deposits, are short term. If they engage in too much infrastructure lending, they will suffer from an increasingly unstable maturity mismatch.
Capital inadequacy
Capital markets, by contrast, are much better suited for infrastructure financing. Unfortunately, although India's stock markets are thriving, its debt markets are in their infancy.
There are a host of reasons for this. One is that there is no real interbank rate off which to price loans, since banks are reluctant to lend to each other for more than the briefest durations. Another is that witholding tax on coupons deters foreign buyers. Nor are there many domestic buyers of long-term debt, since insurance companies and pension funds, who would normally snap up long-dated securities that match their liabilities, are not well developed.
Meanwhile, regulators have frowned on innovations like securitisations and credit default swaps. That seemed sensible during the financial crisis -- regulators worry that financial instruments removed from the underlying risk event promote cavalier behaviour. Yet sensible securitisation and credit insurance would enable banks to lend more to infrastructure, without loading up their balance sheets with long-term loans.
That is changing, but at a glacial pace. Guidelines on CDS have been published, but holders will only be able to use them to hedge the underlying risk, and not to trade freely. What's more, a long-promised plan to allow foreigners to take bigger stakes in Indian insurance companies -- something which could help beef up that fledgling sector -- is still stuck on the drawing board.
Financial reform alone won't solve India's infrastructure problems. Arguments between government agencies and companies over who owns land, and confusion around environmental policies, must be swept away too -- and, of course, corruption must be rooted out. But unless reforms and innovations are put in place to ensure capital gets to projects that need it, India's rapidly growing economy will struggle to maintain its punch.
India needs solution to $1.5 trillion puzzle - The Economic Times
Poor infrastructure is one of the main things holding India back. Poor logistics cause waste equivalent to 5 percent of GDP, according to McKinsey. Roads such as the "golden quadrilateral" -- joining the country's biggest four conurbations -- are being laid down, but not rapidly enough. No wonder the roads minister was shifted in a cabinet reshuffle earlier this month. An estimated one-third of all fresh produce spoils before it reaches the market, and most of the country's railways predate independence in 1947. There are chronic electricity shortages in most states. And then there are the heaving cities, suffering from poor sanitation and virtually bereft of mass public transport.
The government and its planners see the problem. The ongoing five-year plan called for $500 billion of infrastructure investment. The next, which runs until 2017, will argue for $1 trillion. With India's public debt at over 60 percent of GDP, and a current account deficit touching 4 percent, plans to put up half of that from public finances seem less than ideal.
Foreign direct investment can play only a small role. FDI was $24 billion in 2010, according to the International Monetary Fund, only a quarter the amount China attracted, and not all of India's inflows went to infrastructure. Foreign investors are still largely deterred from building projects because of uncertainty over policy logjams and ever-present corruption.
Don't bank on it
Meanwhile, India's banks are also financially constrained. Part of the problem is that the banking industry -- much of which is state-controlled -- needs more capital to keep up with India's rapid growth. To finance real GDP growth of 10 percent, given inflation of say 5 percent (which is less than India currently experiences), loans probably need to increase by something over 20 percent a year. Of course, the banks can go to the market and raise the necessary capital -- indeed, a rash of equity issues is expected this year. But if the state wishes to maintain its stakes in the banks, it will need to dig into its own, bare pockets. Even if it can find the cash this year, it may need to see itself diluted in the longer term -- and that will require changes to the law, a tricky proposition given that India's corrupt politicians see state banks as their playthings.
It would also be easier to finance lending growth if the banking industry was opened up to more new entrants. Foreign banks want a bigger slice of the cake, but they have to beg to get every single extra branch. India's non-banks are also lobbying to be allowed to get into the market. Liberalisation may happen -- the authorities are examining the issue -- but the existing players have a strong vested interest in preventing more competition.
Even if these issues are dealt with, banking is not the ideal solution for infrastructure financing. Loans need to be long-term, say 15-20 years. Yet banks' liabilities, such as deposits, are short term. If they engage in too much infrastructure lending, they will suffer from an increasingly unstable maturity mismatch.
Capital inadequacy
Capital markets, by contrast, are much better suited for infrastructure financing. Unfortunately, although India's stock markets are thriving, its debt markets are in their infancy.
There are a host of reasons for this. One is that there is no real interbank rate off which to price loans, since banks are reluctant to lend to each other for more than the briefest durations. Another is that witholding tax on coupons deters foreign buyers. Nor are there many domestic buyers of long-term debt, since insurance companies and pension funds, who would normally snap up long-dated securities that match their liabilities, are not well developed.
Meanwhile, regulators have frowned on innovations like securitisations and credit default swaps. That seemed sensible during the financial crisis -- regulators worry that financial instruments removed from the underlying risk event promote cavalier behaviour. Yet sensible securitisation and credit insurance would enable banks to lend more to infrastructure, without loading up their balance sheets with long-term loans.
That is changing, but at a glacial pace. Guidelines on CDS have been published, but holders will only be able to use them to hedge the underlying risk, and not to trade freely. What's more, a long-promised plan to allow foreigners to take bigger stakes in Indian insurance companies -- something which could help beef up that fledgling sector -- is still stuck on the drawing board.
Financial reform alone won't solve India's infrastructure problems. Arguments between government agencies and companies over who owns land, and confusion around environmental policies, must be swept away too -- and, of course, corruption must be rooted out. But unless reforms and innovations are put in place to ensure capital gets to projects that need it, India's rapidly growing economy will struggle to maintain its punch.
India needs solution to $1.5 trillion puzzle - The Economic Times
