Will banks pose a problem for India's infra growth?

Jul 15, 2014

In this issue:
» Reforms for banking sector on the cards
» Will a special fund for start-ups work?
» Does a rise in CV sales signal an uptick for the economy?
» Is the US as corrupt as developing economies?
» ...and more!

That the Modi government wants to give infrastructure a big push is apparent. After all, that was one of the key factors that dominated its election campaign agenda. What more, in the recent Budget too, the thrust on infrastructure was obvious as the FM spoke of increasing investments, improving productivity and more outlays for new projects and programmes.

As we wrote in a recent edition, the Budget's thrust on infrastructure funding is the only hope for reviving the otherwise moribund sector. One such proposal was the 5:25 financing for infrastructure projects. This would allow banks to lend to a developer for 25 years with the option to rewrite the terms of the loan and possibly even transfer it to another entity's balance sheet after 5 years. Of course, infrastructure companies have welcomed this move. Most banks and infrastructure finance companies were offering loans of tenure upto 12-15 years. Thus, given that infrastructure projects are quite long term in nature, the 5:25 structure bodes well for a sector which needs funds to execute projects.

Not surprisingly, banks are not too happy with this. One of the reasons why there is not much comfort for high tenure loans is the issue of asset liability mismatch. More importantly, banks are worried and quite rightly so of the possible rise in bad assets or restructuring of assets. Indeed, quite a few loans to the infrastructure space have gone bad, especially the ones where the projects have stalled. Indeed, as per an article in the Mint, as of March 31, 2014, infrastructure loans worth Rs 572 bn were under corporate debt restructuring (CDR). This accounted for around 20% of all loans to all sectors.

So what is the solution? One of the things that the government intends to do is reduce the CRR and SLR requirements so that banks have more funds at their disposal. But that does not address the crux of the problem. The issue here is the probability of loans going bad. And the chances of this will reduce if projects are executed on time and there are no serious hurdles which would stall them. So far, many projects have been stuck because of issues relating to land acquisition, lack of environmental and other governmental clearances. Not to mention, the lack of fuel for power plants. And this has become a vicious cycle because delays have automatically raised the cost of these projects leaving the developers cash strapped and banks facing the spectre of a rise in bad loans.

If the rampant red tapism is done away with in the first place with a focus on speedy clearance process, there is no reason why projects would not be implemented on schedule. And once that starts to happen and the cash flows become more regular, banks would be willing to lend for a longer duration if so required.

All in all, the government and the RBI will have to work in tandem to strike the right balance and ensure that there are no more hurdles in ramping up infrastructure, as this is critical in ensuring a sustained high GDP growth for the country in the longer term.

What do you think the government needs to do to ramp up infrastructure growth in the country? Let us know in the Equitymaster Club or share your comments below.

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Whether or not the case is similar for other sectors, reforms for the banking sector is certainly on the cards. The Union Budget has made this amply clear. PSU banks have so far been an important source of dividend income for the government. Moreover, they account for nearly 70% of the banking sector. Hence ensuring that they stay profitable is a critical responsibility of the government. The UPA government has so far struggled to recapitalize the PSU banks every time they fell short of funds to meet the BASEL criteria. This time the banks need as much as Rs 2.4 trillion to meet the Basel III norms. The NDA government has proposed that it will pare its shareholding in PSU banks mainly through retail share sales. Besides shoring up the capital adequacy of banks, it will also help in increasing the minority share holding in these banks. Having said that the government is not considering lowering its stake in these lenders below 51%. In addition, the government is considering a fixed tenure for the chairmen of the banks and offer more autonomy to them. This will make the banks more efficient and accountable. SBI's merger with subsidiaries and consolidation of problem ridden banks like Dena Bank and United Bank of India may also be on the cards.

There's this scene in the movie The Social Network where the President of the Harvard University makes an interesting point about the university. He opines that Harvard undergraduates believe that inventing a job is better than finding a job. Guess who took an inspiration from this. Well, it's our very own Finance Minister Arun Jaitley. For he's proposed a fund of a size of a whopping Rs 100 bn as a catalyst to attract private capital. In other words, the Government is not just looking to create jobs; it is also keen to help people invent new ones. And the effort is certainly laudable we believe.

However, allocating money is the easy part. The real challenge would come at the time of execution. And unfortunately there's hardly any clarity on this. Entrepreneurs are of the view that the fund should at least have a five year horizon as one has to be patient with new businesses. Besides, the fund needs to be managed by people with expertise across different fields like industry, bureaucracy and also venture capital. Another point worth considering is that an overwhelming majority of start-ups fail within the first three years itself. Therefore, the Government should be willing to live with this kind of risk. In short, getting this project off the ground is certainly not going to be easy.

 Chart of the day
Sales of heavy commercial vehicles (HCVs) rebounded in the quarter ended June 2014 or 1QFY15. This is after a decline of two years, thus providing an indication that the economy has indeed bottomed out. As can be seen from today's chart of the day, sales of HCVs were higher by 11% YoY as compared to the corresponding quarter of previous year, a change in trend after two years.

A mix of factors led to the same. Firstly, there would be the low base effect. As you would be aware, CV sales declined sharply for two years straight, something that the industry has not witnessed in decades. The second key factor is the rising freight rates (as reported by the Business Standard) which are up by about 12% to 15% in the past six months. Thirdly is the extension of excise concessions; lastly is the overall improvement in sentiments. Given the focus on picking up infrastructure and mining activity by the new government, the CV industry will be a key beneficiary of the same. Having said that, one should not forget about the surge in stock prices of CV manufacturers; a broad based recovery seems to be priced in.

Heavy CV sales rebound in the June 2014 quarter

Nine months back it was credit growth and now its property hazard. We are talking about the shift in the biggest risk that Chinese economy is encountering over the stated period. Not surprisingly, credit growth risk is now replaced by property market risk since the presence of former sows the seeds of latter. Unprecedented credit growth would obviously mean that money would move into asset classes like real estate, gold and equities thereby inflating their prices.

For China, it happened to be real estate since it was a developing country. Massive credit flow led to construction boom. However, with urbanization having peaked, now there is an oversupply in the real estate market. Suffice to say with affordability becoming an issue, Chinese urbanization dream has turned into a ghostly nightmare. With property developers offering discounts to offload inventory there is a worry that if the stock pile does not get liquidated, the banking industry could come under stress. This is because quite understandably, it has been financing property transactions. Even manufacturing and services sector growth could be hit as both are closely tied to real estate. There is no denying the fact that China went into an overdrive and overinvested in infrastructure and real estate. This has led to a massive bubble brewing in the economy we reckon.

The stigma of corruption is often attached to developing countries rather than developed ones. However, an article in Businessweek points out that looking at things from a wider perspective, developed countries including ones like the US and the UK may not be very far away from the likes of Nigeria and Bolivia. For corruption does not relate only to bribe taking. Corruption extends to much more than that. Governments and other authorities using their power to serve a select few, for example. A more wholesome definition of corruption demands that one looks at whether the government and the political system in a particular country is fair or self-serving and stacked against most of its citizens. From this perspective, the difference between corruption in countries like the US and developing countries may not be that big after all.

In the meanwhile, the Indian stock markets pared gains but continued to trade positively in the post noon trading session. At the time of writing, the BSE-Sensex was trading higher by 89 points. Majority of the sectoral indices were trading in the green led by Banking and consumer durables stocks. On the other hand IT and FMCG stocks were witnessing selling pressure. Most of the Asian indices were trading in the green led by Korea. European markets have opened flat today.

 Today's investing mantra
"The difference between a good business and a bad business is that good businesses throw up one easy decision after another. The bad businesses throw up painful decisions time after time." - Charlie Munger

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5 Responses to "Will banks pose a problem for India's infra growth?"

hoshang dehnugara

Jul 16, 2014

govt has to do infra dev on its own and not to disturb nat banks, reasons stated by you are absolutely correct. i find the whole of your right up correct. like bjp, in our country and shiv sens in maharashtra developed road/ flyover projects.



Jul 15, 2014

If India want to be on the forefront among the emerging economies and majority of Middle-class Indians are now ready to undergo reforms even at the cost of any eventuality whatsoever, structural changes and modifications in in infrastructure is prime and vital important. Any layman can understand with the present infrastructural system we would not reach anywhere!



Jul 15, 2014

Whether infra loan, car loan, personal loan add the spouse or any female house hold closely related to the borrower like wife, sister or mother as a co-borrower.In case of default the female co borrower will be more sensitive to police case or court case. 95% of the loan can be recovered due to the presessure of female counter part to the male borrower to repay the loan by hook or crook



Jul 15, 2014

I entirely agree with you that infrastructure is the backbone of any economy. This is particularly so for India to develop this sector faster as it can give a boost to other sectors in the long run.
At the sane time, there should be a full proof mechanism to monitor utilization of funds allocated by banks.



Jul 15, 2014

Is red tape the only problem plaguing infrastructure sector? What about rampant corruption with corporate sector being hand-in-glove with the babus or vice-versa?

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