Report this week on how India’s infrastructure projects are increasingly being financed by foreign capital as Indian banks are shying away from project finance:
This is a sign that the domestic funding pipe, which broke after the debacle at Infrastructure Leasing and Financial Services Ltd, is yet to be completely fixed. Surely, when the country’s largest lender, State Bank of India, reported no growth in corporate loan offtake for the December quarter, it points to one thing. Lenders are still preoccupied with fixing legacy bad loans. Private sector lenders that have fared well, too have kept away from big sanctions.
Financing long-term capital expenditure in India has always been a problem. This RBI working paper from 2019 [PDF] on the under-developed state of the Indian corporate bond market describes how Development Finance Institutions in South East Asia were set up explicitly for financing projects that would begin paying off ten years or more after financing. However here:
In India, development banks were gradually converted into universal banks, based on the recommendations of the Report of the Working Group on the Development Financial Institutions (DFIs) (RBI 2004).
Which means short-term deposits from individuals and companies are being used to finance long-term projects. This imbalance in liquidity creates several problems, not least that a default or delay by a project puts individuals’ bank deposits in jeopardy. The paper goes on:
In India, the proportion of firms using banks as the primary source of working capital is higher than most developing countries. Further, the proportion of loans requiring collaterals as well as the value of collateral (as proportion of loan) are among the highest in India. This indicates the prevalence of asset-backed lending in India, which is essentially a feature of a relatively less developed financial system with limited expertise to gauge the credit risk of unsecured lending.
As a result of this, the effective borrowing cost increases and therefore
The large corporates can raise debt from the overseas markets, the cost of which, even after adjusting for hedging cost, tends to be lower than the cost of borrowing through the domestic market-based sources.
Which brings us full circle. An underdeveloped corporate bond market leads to an over-reliance on banks and short-term savings account deposits to fund much longer-term projects, therefore requiring collateral, raising the costs of borrowing, making it easier to borrow from overseas.