Ask a banker, she does not know. Ask an infrastructure developer, neither does she. The economist says she has no idea. The Indian central bank’s proposed guideline to raise provisioning for infrastructure projects has left all three groups confused. Even the Union Ministry of Finance is unsure why the Reserve Bank of India (RBI) suggested such a guideline at a time when private investment has just started showing signs of recovery after a long pause.
The guideline, issued recently by RBI, asks lenders to increase provisioning for loans for infrastructure projects nearly 12 times from what it is now. With the proposed guideline, RBI aims to increase standard asset provisioning from the current 0.4 per cent to 1–5 per cent, going down as the project progresses. This means a bank must set aside a significantly higher portion of loan exposure than it does now.
Sources in the banking industry say that if the proposed guideline goes through, it could trigger a steep rise in interest costs for infrastructure companies. Infrastructure developers think the move could slow the growth momentum of the economy. Economists wonder why the central bank is thinking of such a move when bad loans in the country are at a decadal low. Finance ministry officials say the government is studying the draft guidelines and will send in its response if required.
Guideline, if Passed, Could Impact Investment
Since the pandemic, the Union government has invested heavily in the hope that government investment will spur private investment. Between 2019 and 2024, the Union government’s share of investment in the economy rose by 226 per cent. In the same period, private investment rose around 54 per cent. Additionally, as a share of gross domestic product (GDP), there has been a significant fall in private investment from 27 per cent in 2010–11 to about 20 per cent in 2020–21.
Economists say it is time for the private sector to take the lead in driving India’s growth, currently at around 7 per cent, due to the government’s fiscal constraints. In a recent interview with Outlook Business, economist Bibek Debroy, chairman of the Prime Minister’s Economic Advisory Council (EAC), said, “Given the fiscal consolidation deficit reduction requirements, I do not think we can expect much more as an increment for government expenditure. The growth drivers, therefore, have to increasingly be consumption and private investment.” In the interview, Debroy had said he sees private investment and consumption showing signs of recovery.
For this hope of recovery to be realised, the RBI’s draft guideline could become a roadblock.
Banks and Non-Banking Financial Companies (NBFCs) say higher provisions for ongoing projects could increase costs of infrastructure lending. They want the central bank to reconsider the proposed guideline.
Economists at CareEdge Ratings, a Mumbai-based credit rating agency, say the sharp increase in provision for loans will have a direct impact on the cost of debt which in turn will dampen the bidding appetite of infrastructure developers in the medium term.
Ashok Singh Jaunapuria, managing director and chief executive at real estate development company SS Group, says increased borrowing costs will discourage private investment. “Credible developers with strong credit ratings may face fewer challenges compared to smaller developers, especially in tier-II and tier-III cities with such a move,” he says.
“Small-scale developers depend significantly on banks and funding from financial institutions to complete their projects. Tighter lending restrictions may make it harder for them to get the money since lenders might be less willing to give credit particularly for riskier or lower-profit projects,” he adds.
Something Similar Happened Last Decade
In 2015, the central bank had taken several measures to reduce the proportion of non-performing assets (NPAs). At the time, the RBI had come up with a policy of asset quality review (AQR) that mandated banks recognise and provide for stressed assets in a more transparent and stringent manner.
As banks increased provisions for NPAs, their ability to extend fresh credit reduced sharply. Credit growth in the industrial sector, particularly large industries, declined. According to RBI data, the growth rate of bank credit to industry fell from 7 per cent in 2015 to a negative 1.9 per cent in 2017.
The credit crunch contributed to a significant decline in private sector investment. Gross Fixed Capital Formation (GFCF), a measure of private investment, showed a decelerating trend, reflecting reduced private investment. Private investment growth rate slowed from 6.1 per cent in 2014–15 to around 2.9 per cent in 2017–18.
Why is RBI spooked?
The Reserve Bank has not specified a trigger for the proposed guideline. A section of bankers says the central bank is exercising caution taking lessons from how things unfolded in the previous infrastructure investment cycle between 2009 and 2015. “[The] RBI has grown wary of any sudden growth. In our view, they [the central bank] are taking cues from the past and all that has happened in other countries,” a senior official at a prominent state-owned lending institution said on condition of anonymity.
Exposure on infrastructure loans has been on the rise in recent years growing from Rs 10.4 lakh crore in 2018–19 to around Rs 12 lakh crore in 2022–23, RBI data shows. This could mean the central bank wants to stay ahead of the curve as a matter of prudence given India’s current focus on infrastructure projects.
Some experts also think that the recent real estate meltdown in China could have prompted the central bank to adopt a more cautious stance on infrastructure lending. For years, China relied on infrastructure to drive its economic growth. However, aggressive lending towards infrastructure projects has led to a significant accumulation of bad debts for China’s banks and local governments.
“The RBI might have a longer-term vision in mind. In the future, we might conclude that things would have been worse if they had not tightened lending to infrastructure projects,” says former RBI governor Duvvuri Subbarao.
Clashing Priorities
One could argue that RBI’s caution is well intended, but one would do well to remember that there have been numerous instances when non-monetary measures employed by central banks have had adverse effects on economies. For example, in Hong Kong back in 2009, in a bid to cool an overheated property market, Hong Kong’s central bank—the Hong Kong Monetary Authority (HKMA)—implemented stringent macro-prudential measures, such as increasing down payment requirements for property purchases. While the intent of these measures was to enhance financial stability, it also made housing unaffordable for many.
Some banks and NBFCs want the finance ministry to make RBI reconsider the proposed guideline. The finance ministry too is closely monitoring the matter since it has allocated significant funds to attract private investment. Now that these investments have started coming in, the ministry would not want the momentum derailed. Sources say the Union Ministry of Road Transport and Highways wants current financing rates maintained.
“An economy’s ability to grow is usually increased by investments in infrastructure projects,” says Jaunapuria of realtor group SS. “With these draft norms by RBI, infrastructure expenditure could take a potential hit due to increased lending costs and operational changes associated with compliance,” he adds.
While the RBI’s guideline is still only a proposal it has already started showing an impact on the stock markets. Several infrastructure public sector undertaking (PSU) banks and NBFCs such as Power Finance Corporation, REC and the Indian Renewable Energy Development Agency (IREDA) have seen their stocks tumble.
Will the RBI walk back its caution? Will over-caution slow growth? Or will growth continue at momentum despite RBI’s stance? Only the future holds all the answers.
