Why a new NBFC as guarantor for lower-rated infra bonds won’t help

Credit enhancement entities play a crucial role in supplementing the credit ratings of bonds associated with above-investment grade operational infrastructure projects.

Media reports suggest that the government is contemplating the unveiling of plans for a new NBFC, crafted to function as a guarantor for lower-rated infrastructure bonds. The anticipated outcome of this initiative is the potential enhancement of project ratings, subsequently contributing to an improved credit risk profile for infrastructure companies, thereby facilitating more favourable terms for securing funding.

Securing financing for infrastructure projects has taken on increased significance against the backdrop of India's flourishing infrastructure development. With annual investments in infrastructure ranging from Rs 8-10 trillion and a growing commitment to transition to NetZero, the need for robust credit enhancement mechanisms has become more pronounced. As India delves into more extensive and innovative infrastructure construction, the role of dedicated financial institutions becomes an economic force multiplier.

Mired In Disagreements, Delays 

The introduction of another government-backed NBFC raises concerns about the redundancy of such entities and their questionable effectiveness. Rather than resorting to the creation of additional bureaucratic structures, exploring avenues within the regulatory framework for guarantees or incentives might prove more prudent.

While acknowledging the financing needs of state government projects, particularly the last mile schemes, that despite the announcement of plans to establish an NBFC for augmenting capital availability in infrastructure financing, tangible progress remains elusive. The Finance Minister had initially introduced this plan in the 2019-20 budget.

However, the subsequent delays, attributed to disagreements among various government departments during prolonged inter-ministerial consultations, underscore the challenges of translating announcements into concrete actions. A prior proposal included the establishment of entities such as the Credit Guarantee Enhancement Corp or National Infrastructure Credit Enhancement Ltd, equipped with an initial authorised capital of Rs 20,000 crore and envisioned to receive equity participation from other state-run financial institutions.

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It did not kick off considering the various delays, bureaucratic hurdles and even the purported governmental rethink in the light of similar facilities available with existing framework.

Why Credit Enhancement Entities Matter

Credit enhancement entities play a crucial role in supplementing the credit ratings of bonds associated with above-investment grade operational infrastructure projects. This enhancement increases the appeal of these projects to institutional investors by providing partial or full credit guarantees.

But to be effective, and have lasting impact without any financial risk, the State governments and municipalities must elevate their financial behaviour and embrace robust fiscal governance to catalyse successful project financing. Relying solely on government guarantees without concrete revenue accruals for infrastructure projects is an economically unsustainable approach.

To garner investor confidence and foster sustainable development, public entities need to demonstrate fiscal responsibility. In the 21st century, effective public governance demands a balanced approach to pricing public services, striking a balance between social obligations in providing access & social justice, and with economic stability.

No Lessons Learnt

Attempting to juggle the roles of financier, regulator, and sponsor, the Government risks assuming superpowers and technical expertise it might not possess. Bureaucrats overseeing these multifaceted roles are often generalists, lacking the specialised knowledge required for effective decision-making in development financing.

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It is crucial to recognise that financing development sectors demands expertise, and this should be entrusted to specialists with regulatory oversight of the RBI. Establishing clear regulatory expectations for existing lending institutions to provide minimal exposure to the developmental sector could foster a more effective and sustainable approach.

Looking back, Indian market history offers a cautionary tale about converting focused developmental financing institutions into general banks. This shift led to the loss of specialised talent and diluted the institutions' effectiveness. The government must heed these lessons and resist the urge to intervene directly in sectors where it may feel a shortage of financiers. Instead, regulatory incentives can be employed to stimulate interest from private financiers who possess the necessary expertise, avoiding the pitfalls of the government engaging in businesses it does not fully comprehend.

In infrastructure financing, market-based mechanisms have a proven track record for sustained and impactful results. The government's own struggles with its bad bank concept underscore the challenges of relying on centralised entities for financial solutions. The historical track record with developmental financing entities like NABARD and SIDBI, despite their longevity, has been characterised by incremental impact at best.

They have been around for long, and yet they have been only incremental in their value add to the sectors they focus on. In transforming sectors like agriculture, MSME, or infrastructure, incrementalism or populism don’t make for financial performance or social transformation. Adding another NBFC would not be a meaningful addition to Indian infrastructure financing.

Srinath Sridharan is Author, Policy Researcher & Corporate Advisor, X: @ssmumbai. Views are personal, and do not represent the stand of this publication.