By Harman Mangat
Following the global financial crisis in 2008 and the cancellation of 2G telecom and coal mining licences, several infrastructure projects in India were brought to a standstill, thus negatively affecting bank balance sheets. In 2012-13, Indian banks reported significant defaults on infrastructure loans due to excessive lending, straining the country’s bank lending system. A few years later, the Covid-19 outbreak further dampened credit growth. By 2022, the economy witnessed a gradual rebound in bank credit, renewing hope for the infrastructure sector.
The investment surge and increased focus on green growth have accelerated infrastructure project activity, particularly energy projects. Given the twin balance sheet problem in the past and other lending mishaps, the Reserve Bank of India (RBI) has released draft guidelines for financing under-construction commercial real estate and infrastructure projects. These draft recommendations seek to strengthen appraisal mechanisms, and ensure timely completion and discipline in consortium funding, with a focus on plugging gaps to prevent the creation of non-performing assets (NPAs) in the sector. These measures are anticipated to reduce the lending risk associated with long-gestation infrastructure projects.
Although the guidelines prioritise long-term financial sustainability and safeguard lenders from potential defaults, the increased cost of borrowing may discourage lending in the short term, potentially impacting planned energy projects.
The market has reacted negatively to the significant increase in lenders’ provisioning requirements (amount set aside by banks to meet future expenses and risks), which has jumped over 12 times from the previous 0.4 per cent to the current 5 per cent. While the RBI’s aim to focus on positive net present value (NPV) for better project structuring and potentially creating a pipeline of bankable projects is a welcome move, the proposed measure is likely to directly increase the cost of borrowing, which may further impact project viability.
Higher provisioning requirements will significantly impact the availability of lending capital and lenders’ appetite, effectively decreasing the overall capital available for energy projects. Shortly after the announcement, the stocks of Rural Electrification Corporation Limited, Power Finance Corporation Limited, and Indian Renewable Energy Development Agency Limited, state-owned non-banking financial companies for financing energy and power sector projects plunged by 11-12 per cent.
Furthermore, public sector banks with significant exposure to energy projects, such as the State Bank of India (SBI), may also potentially witness substantial losses. In anticipation of this, SBI has already started altering its future loan agreements, introducing a new clause that allows it to “pass through” any additional costs from increased provisioning directly to the borrower.
Moreover, the draft guidelines fail to adequately differentiate between the infrastructure and real estate sectors. Even within the infrastructure sector, a nuanced, sector-specific approach is required for sectors like renewable energy and power. Financing guidelines should ideally be calibrated based on the risk profile of each sub-sector and project type.
As per industry experts, the energy sector, in particular, has historically exhibited zero loss given default (LGD). Hence, any LGD or probability of default cited as the basis for the proposed guidelines should be made public.
While the RBI’s focus on ensuring positive NPV for projects is positive, it is crucial to consider the potential impact of such policies on the country’s overall growth and development. Sectors like renewable energy, which heavily rely on external financing, may face greater challenges compared to other sectors such as roads and railways, which rely on more conventional sources like the Union Budget.
To sustain the economic momentum, a well-regulated funding for infrastructure development is necessary to scale up investments. This includes continued capital market development and facilitation of bank loans for projects. Overall, the new guidelines should not slow down the ongoing infrastructure development activity in the country.
Due to longstanding structural issues like NPAs and bad debts and associated risk aversions, strong regulations aimed at long-term financial stability are ultimately necessary for India. These regulations may potentially hinder the flow of energy investments in the near term, particularly when the capital requirement for infrastructure development is at an all-time high. While these regulations may appear stringent in the short term, financiers are expected to readjust their funding strategies, as done by SBI, in line with the final guidelines.
The regulatory framework must strike a balance between financial stability and economic growth. Policymakers must carefully weigh the implications of the proposed policy to ensure that it does not inadvertently hamper the growth and development of critical sectors like energy, which is a cornerstone of the country’s economic progress.
