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Debt Finance Reforms to Attract FDI in Infrastructure in India

Jan 24, 2018 10:34 AM 3 min read

As news of the Foreign Direct Investment (FDI) regulation changes in India hit the newswires last week, in another part of the world, the Government Pension Investment Fund (GPIF) (the largest pension fund in the world) in Japan announced the manager for its core infrastructure mandate. Though the FDI policy announcements are a step in the right direction, it is now time for a renewed focus on addressing issues around debt finance in India. Foreign borrowings in India are governed by the External Commercial Borrowing (ECB) Regulations and the government must ensure that the right policies are put in place to provide further impetus to India's growth story.


Pension funds and insurance companies across developed economies are looking for investment opportunities in India. The key for India is to utilize this investment sentiment and actively attract the fixed income component of the global portfolios.


In common parlance, fixed income investments are bond like structures that investors invest in generally for a steady stream of income. To understand the global scenario better, one must first understand the yield compression in bond markets globally. The yield on the 10-year Japanese Government bond was last at 7.5 basis points in 2018 as against 121 basis points in January 2011. While in nominal terms that is approximately a 113-basis point compression, in percentage terms that is a 93% yield compression. Such yield compression means that global investors like the Japanese Pension Funds are searching for assets that provide them with the required steady income streams. It is here that Indian policymakers have an opportunity to further improve policies to attract foreign debt finance in India.


Policies must further promote the use of relatively inexpensive debt from foreign investors (in countries with relatively lower interest rates) to fund assets in India especially in crucial infrastructure sectors. That said, both the partnering countries will have to come up with mechanisms that assist corporates to hedge the foreign exchange risk in such transactions to some degree. It is important to note that by its very nature of being long dated, infrastructure projects tend to be primarily debt financed.


It may be underscored that the recent issues around Non-Performing Assets (NPA) in Indian infrastructure stem from two main sources – poor project selection and expensive debt. Steps towards improving our policies around ECB to create an even more effective debt investment mechanism to attract foreign capital will effectively address the second core issue. As mentioned earlier a country such as Japan and its pension funds have an economy with structurally low interest rates but with a need for steady income and the capacity to lend for long periods of time.


India’s comparative advantage lies in having an economy growing at a relatively much higher growth rate but one which has an infrastructure deficit and infrastructure funding deficit. India needs to focus on creating mechanisms such as tax benefit to debt holders, easier norms for repatriation of profits, greater flexibility around interest ceilings applicable to loans and creation of a secondary market for ECB instruments to enable the flow of investments from nations such as Japan into infrastructure in India.


Creating policies, frameworks and mechanisms to enable the flow of relatively inexpensive debt capital for longer periods of time specifically will also unlock value of infrastructure assets that are not sustainable using relatively short dated expensive debt funding available in India. If access to the long dated low cost foreign debt is given, infrastructure projects will become more economically viable. Long dated low cost foreign debt also reduces the pressure and burden on Indian public sector banks (PSBs) to fund infrastructure projects, which are typically long dated projects that do not suit the bank’s short dated liabilities.


In summary, regulations that enable the flow of foreign capital in the form of debt finance, especially from global pension funds into Indian infrastructure projects will be key to accelerate the Indian growth story. The most important component of this will be ensuring that foreign capital in India is safe and contract enforceability is guaranteed. Investors must have faith in the conflict resolution systems available in the country and government policies must ensure this. There is no doubt that given the investment opportunity in India, fixed income investors globally are keen to partner with us!


Originally Published in Financial Express