It is clear from the Budget and policy initiatives being discussed since then that the government and the Reserve Bank of India (RBI) are concerned about the slowdown in foreign direct investment and the concomitant increasing difficulty in raising finance for infrastructure projects. On the other hand, there are billions of dollars of global investment that is extremely keen on Indian corporate bonds, but the two sides don’t seem to be able to meet.
Global investment intermediaries are frustrated at the small total limit of debt investment permitted, and much more so at the bidding and allocation process articulated by the RBI and the Securities and Exchange Board of India. This creates enormous operational difficulties in terms of planning an investment portfolio and in explaining to global institutional investors that the share of India in their overall portfolio cannot be determined ex-ante. Of course, global investors are, in general, still not comfortable with more than relatively short-term – three years, or five at best – India risk.
It seems that a reasonable via media would be to eliminate the bidding system and open the gates for debt inflows, recognising that we will always be free to close the gates, perhaps temporarily, if we found the inflows difficult to manage. The historic terror at policy reversals is no longer such an issue since most investors now acknowledge the need for prudent management of capital flows. Note, for instance, that Brazil has introduced a type of Tobin tax on inflows and it hasn’t materially impacted its attractiveness.
We should, of course, demand a pound of flesh for this window opening by requiring the tenor of the investment to be lengthened from five to, say, seven years. BIRD 1.
Though this would address the recent slowdown in foreign investment, it would not, in and of itself, solve the problem of infrastructure funding since, typically, such projects need around 15 year-plus money. However, this tenor gap could be addressed if the government were to use its capital more creatively. Rather than using it to simply create fresh infrastructure assets, for which there is plenty of money available globally, the funds should be used to provide cover for the refinance risk.
It would work as follows: An infrastructure company borrows for seven years, either by issuing a rupee bond or through external commercial borrowings. The government issues the company interest rate warrants that provide cover for the refinance risk, enabling other lenders (probably domestic institutions) to underwrite the debt for another 10 years at the current 10-year market rate.
The problem is that since there is no interest rate derivatives market to speak of, it is impossible to price the refinance risk. In the US market, the cost of the risk of refinancing for, say, 10 years after seven years (which would give the borrower a 17-year facility) works out to 1.85 per cent. This is calculated as the difference between the cost of a seven-year forward start 10-year swap and today’s 10-year bond yield.
Recognising that the near-zero liquidity in the Indian market multiplies the risk, we would guesstimate – conservatively speaking – that the cost of the risk for a similar facility in India should be around 5 per cent.
Using this as a benchmark, if the government were to budget Rs 2,000 crore, it would provide tenor support for an infrastructure financing of Rs 40,000 crore, or nearly $10 billion. BIRD 2. Note that this money would not necessarily be lost to the market — if the 10-year rate did not rise above today’s level of 8 per cent, there would be no cost; if it rose to, say, 10 per cent, the cost would be 2 per cent (or Rs 800 crore on Rs 40,0000 crore of assets); and, indeed, if the 10-year rate were to fall to, say, 6 per cent, the government would earn Rs 800 crore.
Now, while I fully understand that it is not the government’s job to punt in the interest rate derivative market, I do believe it is the government’s job to ensure that infrastructure projects get appropriately priced long-term funding — some version of this is what the Chinese government does. Since private investors are more than willing to take on the credit risk, all the government has to do is enable the tenor. To my mind, the cost seems eminently reasonable.
Not only this, once the government were to prime this market, it would, in a sense, create a benchmark price for a forward start swap for the Indian market. Indeed, if the government were to provide cover for different tenors – say, 7 x 10, 5 x 10 and so on – it could also serve to kick-start the stillborn interest rate derivatives market. BIRD 3.
