Financial stability in jeopardy

The UNCTAD's 2018 Trade and Development is an eye-opener that all is not good with the global economy and hyper-globalisation pursued for some time now has only widened inequality. In the case of India, bad debt of banks is threatening financial stability.

The report released recently clearly states that the ongoing trade wars are symptoms of deeper economic malaise. Huge investments in infrastructure development in countries like India are not necessarily helping developing nations to transform their economies and achieve sustainable prosperity.

While infrastructure projects in developing countries are back on the agenda, with multilateral financial institutions such as the Asia Infrastructure Investment Bank scaling up investment, and several international initiatives – such as the Belt and Road initiative of China – putting infrastructure at their centre, the report states such efforts may not help countries promote much-needed industrialisation and structural transformation.

In India, many of the commercial banks, particularly public sector banks, are running huge bad debts because of massive lending to infrastructure projects which had long gestation periods. The latest to join the NPA bandwagon is NBFC IL&FS with huge exposure to infrastructure. Gold plating of projects costs is one of the reasons for such huge NPAs in India.

China too witnessed a similar problem in the 1990s and 2000s, which required a huge bailout of banks by the government. China also used part of its foreign exchange reserves, now over $3.5 trillion, to bail out its banks.

An analysis by UNCTAD in the report of over 40 national development plans from developing countries and least developed countries, which examines the extent of this disconnect, suggests that there is too much emphasis on infrastructure as a business opportunity and too little emphasis on its links to structural transformation.

Despite infrastructure spending conjuring up images of traditional public goods such as highways, ports and schools, policy debate often denigrates the public sector and lauds the role of private capital and, often opaque financing techniques. The report states that this is a long way from the narrative that made infrastructure a central building block of successful industrialisation episodes, from 18th century Great Britain to 21st century China.

This observation assumes significance in the face of the problems in IL &FS in India as well as the failure of the Public-Private Partnership (PPP) model pursued for infrastructure development.

Not only has this crucial link between infrastructure and industrialisation been forsaken in a discourse on the bankability of projects, recasting infrastructure as a financial asset class for international institutional investors has also opened it up to rent-seeking behaviour.

The report states that bankability ironically will not close the financing gap for economic infrastructure investment, whose total annual financing needs, according to recent estimates, range from $4.6 trillion to $7.9 at the global and sectoral level, and require increased public spending.

The bankability approach avoids the key question of how infrastructure can become a force of productivity-enhancing structural transformation and deliver much needed economic and social change in most of the developing world. A good example in India is the Rs one lakh crore bullet train project to connect Mumbai and Ahmedabad.

The report said the world economy remained on shaky ground a decade after the 2008 financial crisis. According to UNCTAD Secretary-General Mukhisa Kituyi, the immediate pressures are building around escalating tariffs and volatile financial flows but behind these threats to global stability is a wider failure – since 2008 – to address the inequities and imbalances of the hyper-globalised world. Trade under hyper-globalisation has failed to foster broad-based structural change in developing countries and has contributed to increased worldwide inequality, UNCTAD said.

Though India is now the fastest growing economy clocking 7.7 per cent in the first quarter of 2018, there are some major concerns in the economy. It warned that a lending spree by the banking system during the high growth years has led to an accumulation of large volumes of bad debt or non-performing assets in the balance sheets of leading banks. This, besides threatening financial stability, is curbing credit expansion and is likely to adversely affect investment and growth.

Further, the Indian rupee is under pressure on foreign exchange markets. Over the first five months of 2018, rupee had depreciated by more than 7.5 per cent relative to the dollar. This is significant as much of trade and foreign debt of India is denominated in dollars. This has also widened current account deficit as global crude oil prices rose sharply. The fear is not so much about the weakening of growth as monetary tightening starts but this would trigger capital outflows leading to further financial and currency instability.

Though India is on a sweet spot at the moment, going forward, the picture is somewhat gloomy as we enter 2019 since global situation, trade wars, and poor health of Indian banking system could derail economic growth going forward.

The UNCTAD report rightly suggests that policymakers including in India should adopt a bottom-up approach to infrastructure investment and place greater emphasis on planning, to enable rapid structural transformation. The links between infrastructure and transformation are best forged when infrastructure projects are clearly designed and made part of a wider development strategy that recognises and foster positive feedback loops between infrastructure, productivity, and growth.

The role of planning in actively facilitating this process and investing in skills and institutional capabilities can also help to ensure that infrastructure not only builds bridges but those bridges also deliver sustainable development.

It is really unfortunate that Prime Minister Narendra Modi dismantled the well-oiled Planning Commission in 2016 and replaced it with NITI Aayog, whose role in development and planning is not yet visible and clear.

(The views expressed are strictly personal)