The Roots of India’s Shadow-Bank Crisis
(Bloomberg Opinion) -- When one of India’s largest shadow bankers — an institution with 169 subsidiaries that calls itself Infrastructure Leasing and Financial Services — admitted to a series of defaults last week, Indian markets came close to a crisis. Fearing that a prolonged investment slowdown would intensify, the government invoked a little-known clause in India’s Companies Act and appointed a new board. The rot the defaults revealed is about more than one organization, however, or even this particular moment in the Indian economy’s fragile recovery. Behind the messy descent of IL&FS from a gilt-edged, quasi-sovereign debt issuer to the object of a bureaucratic bailout lies one unpalatable truth: India hasn’t a clue how to pay for infrastructure.
It’s not as if the government hasn’t tried. Soon after taking power, Prime Minister Narendra Modi’s administration doubled down on public spending on roads and Indian Railways, hoping the investment would pay for itself in a revival of private-sector activity. It hasn’t, and now the government is running out of fiscal space while bond yields are soaring.
Modi and his officials felt they had little choice. The previous government, under then-Prime Minister Manmohan Singh, had tried to build infrastructure in partnership with the private sector. That model, in which a company would agree to use subsidized resources to build a road or a power plant for the state in return for a cut of the revenue, had collapsed well before Singh was voted out and in fact contributed greatly to his defeat. Contracts were poorly drafted and implemented; accusations of corruption multiplied; the government failed to fulfill its part of the bargain with its private-sector partners; and huge chunks of capital got locked up in half-built projects, sharply slowing growth.
Singh had chosen the PPP model in the first place because he felt that India couldn’t afford to build all the infrastructure it needed — trillions of dollars’ worth — out of taxes that could be better spent on, for example, rural welfare. Modi’s choice of the alternative model is now coming back to haunt him, as distress spreads across India’s vast rural hinterland. On Tuesday, Delhi’s police used water cannons and tear gas on tens of thousands of protesting farmers who were denied permission to enter the capital.
So, if the public sector can’t afford to build infrastructure, and it can’t sign contracts with the private sector to do the job, then what’s left? Couldn’t a private-sector funder aggregate such projects and raise funds for them from debt-market players that would otherwise avoid project finance like the plague? That’s what IL&FS attempted to do. Unfortunately, it ran into the old maturity mismatch problem. Using its quasi-public sector status — it’s a private company, but everyone pretended it wasn’t — it splurged on unsecured debt with a one-year tenure. When its long-gestation projects got held up thanks to land disputes, it suffered a liquidity crisis.
It’s hard to see how this problem can be avoided. Just as when one mortgage fails many others are likely to do so — a root cause behind the subprime blowup in 2008 — when one Indian infrastructure project is delayed, it’s likely others will be, too.
What about creating a fund that raises capital only from long-term investors? That’s the six-year old idea behind India’s National Investment & Infrastructure Fund, in which the sovereign wealth funds of Singapore and Abu Dhabi are major investors. The concept isn’t a bad one.
But it only reduces the problem; it doesn’t eliminate it. In order to reassure foreign investors, the government had to put in almost half the money: It owns 49 percent of the NIIF. That means the size of the fund is limited by the state’s straitened resources. While the government hopes the NIIF will grow to have $6 billion to invest, that’s a drop in the bucket. India’s finance minister estimated in 2016 that the country’s infrastructure build-out would require more than $1.5 trillion over 10 years. It’s tough to see half of that coming out of the Indian government’s budget.
This looks like an insoluble problem. It isn’t, if you believe one simple thing is true: The infrastructure projects worth building are those that pay for themselves in the long run. If that’s the case, there’s got to be a way to structure investment so that they get built. Governments shouldn’t have to put their own money in: They should instead commit to getting out of the way and ensuring that they aren’t doing anything that halts projects before they’re finished.
It’s the private sector that needs to put more resources into figuring out what’s worth building and what isn’t — and how to make money off it. Countries like India are where the potential profits are. Yet, too often, Western finance looks for intermediaries like IL&FS instead of doing its job and evaluating risks itself.
After all, there’s one more model on offer: China’s. The People’s Republic has proved that the government can build infrastructure — too much of it! — if private-sector finance isn’t allowed to operate freely. Unless the capital markets start working to solve the problem of long-term debt, they’re going to find that governments decide they aren’t worth keeping around.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Mihir Sharma is a Bloomberg Opinion columnist. He was a columnist for the Indian Express and the Business Standard, and he is the author of “Restart: The Last Chance for the Indian Economy.”
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