Once Bitten, Twice Shy: RBI Doesn't Want A Replay Of Earlier Up-cycle In Infra Financing

The draft guidelines, released on Friday, propose increasing provisions that lenders will have to make for under-construction infrastructure projects that they have financed. The provisioning for standard assets for projects under construction is proposed to increased in a phased manner -- from 0.4 per cent now 2 per cent effective March 2025, 3.5 per cent by March 2026 and 5 per cent by 2027. The draft guidelines also called for rigorous monitoring of emerging stress. 

The proposals, if enforced, will likely raise credit costs for infrastructure companies, while also affecting profit margins of the lenders. Which is why, investors resorted to huge selling in shares of banks, financial institutions and infra companies when the stock market opened this week.

Stocks of state-owned Power Finance Corporation (PFC) and Rural Electrification (REC) fell as much as 12.6 per cent and 8.9 per cent respectively in trading through Monday and Tuesday. Infra companies such as NBCC, HG Infra and KNR Constructions fell 7 per cent, 6.1 per cent and 5.6 per cent respectively.

Shares of public sector banks were hit harder than private banks, with Canara Bank slipping 7.8 per cent, Bank of Baroda 6.2 per cent and State Bank of India 3.3 per cent. Life Insurance Corp also lost 5.7 per cent.

Some of these shares recuperated in early Wednesday following news reports that the government may step in and that the Indian Banks Association would urge the RBI to review its proposals. The Economic Times quoted Indian Bank CEO SL Jain saying the provisioning requirement appeared high and the RBI would be requested to review the decision after the issue is discussed with the IBA.

The RBI has set June 15 as deadline for comments and feedback on the draft guidelines. Whatever the final outcome be, it is worth asking why the RBI wants to tighten the noose around infrastructuring financing. 

In its opening note to the draft guidelines, the RBI said "these directions are issued to provide a harmonised prudential framework for financing of projects in Infrastructure, Non-Infrastructure and Commercial Real Estate sectors by regulated entities (REs)." The new proposals, it said, were being made "in the backdrop of a review of the extant instructions and analysis of the risks inherent in such financing."

Although, the RBI note didn't mention any specific trigger for the review, experts believe the central bank is looking to be mindful what happened during the earlier upcycle in infrastructure investment during 2009-2015, when bad debts piled up at banks and financial institutions as several infrastructure projects got derailed in the wake of an economic slowdown.

More recently, the China experience could have also prompted the central bank turn somewhat hawkish with regard to infrastructure financing.

China for years has relied on an infrastructure boom to drive its economic growth. Aggressive lending towards infra projects led to a piling up of bad debts for China’s banks as well as its local governments. While there is no official data on the quantum of bad loans, the problem is now starting to haunt Beijing. 

“RBI’s proposals will streamline infrastructure credit in India and make it more efficient,” said Nirupama Soundararajan, founder and partner at Policy Consensus Centre.

Implications Of New Proposals

As stated above, the proposals require banks and other lenders to eventually set aside 5 per cent of the total loan amount for an under construction project. It will then reduce to 2.5 per cent once the project becomes operational.

“This would mean that the higher provisioning norm is applicable only at the first stage when all the necessary approvals and timelines are being put in place. So, in a way, the untenable projects will be eliminated. In a way this is a good step as this would provide uniformity to the infrastructure lending pattern,” Soundararajan said.

According to Alliance for Innovation and Infrastructure (AII), a think tank focusing on infrastructure, China has relied on construction of infrastructure to power economic growth, but that seems to have breached a limit. “Infrastructure projects are no longer giving a significant return on investment, and the Chinese government has certainly signaled a slowdown,” the Alliance said.

Project delays and cost overruns have continued to plague the infrastructure sector. In 2013, former Finance Minister P Chidambaram claimed that the rise in non-performing assets—loans that do not fetch returns—had dented infrastructure lending.

In the last few years, Non Performing Assets in the banking sector have reduced significantly—for the public sector it was about 1.3 per cent in 2023-24 while for the private sector, it was 2 per cent. However, this is largely due to write-offs.

The Narendra Modi government has steadily increased infrastructure spending. In 2021, the government launched its flagship multi-crore PM Gati Shakti infrastructure programme that caught the attention of investors, within the country as well as outside. 

In her Interim Budget 2024 speech, Finance Minister Nirmala Sitharaman said, "Capital spending for 2024-25 raised by 11 per cent to Rs 11.11 lakh crore or 3.4 per cent of GDP."

The thrust on infrastructure spending has seen prices of shares of PSU banks, NBFCs and infrastructure companies zoom over the past year.

The provisioning norms proposed by the RBI now will surely party pooper as these will push up interest rates on infra loans by 1 to 1.5 percentage points, affecting not just the profit margins of the lenders and borrowers but also the growth of the broader economy. Unless, the central bank decides to have a change of mind, after June 15.