RBI cautions against laggards
28 Aug 2014 11:16 PM GMT
Reserve Bank of India’s annual report which has just been released has given a modulated optimistic picture about the Indian economy. It has projected growth rate to pick up from sub-5 per cent to above 5.5 per cent and 6 per cent. This optimism has come in the midst of a year which has seen drought conditions in large swathes of the country. That will obviously affect overall growth.
Hence, if the pace is to pick up, the non-farm sectors must show lively performance. Fortunately, we are seeing some little signs of life in industrial sector, going by the latest indices of industrial production. But these must be sustained if the RBI prognostications are to run true.
But more importantly, RBI has drawn attention to some ground level hitches, particularly in core and infrastructure areas, which should be taken up by the government seriously.
RBI’s annual report has pointed out how and why private sector infrastructure projects were proving to be non-starters. Defects in contracts have largely rendered these projects unviable and the government should look into revising infrastructure contracts with the private sector.
This issue was pointed out earlier in the Economic Survey. The survey is basically the work of the chief economic adviser in the union ministry of finance. During the tenure of Professor Kaushik Basu, when he was the chief economic adviser, the survey had devoted one full section to what was stated as the micro-economic foundations of macro-economic growth.
It was argued that unless the micro foundations were solid and straightened, overall growth cannot happen. Even if there are spurts in growth rate, the constraints posed by ground level problems work as brakes to growth momentum. The hitches in contracts, for example, hurt infrastructure projects in course of their implementation and stalled them. Thus these call for minute attention and they should be reworked.
The RBI annual report, on the other hand, has brought out that the poorly performing infrastructure and core sector were affecting India’s banking industry as well. With infrastructure projects increasingly going into private sector, many of the projects were funded by scheduled commercial banks. Hence, this issue is also important for banking sector since their loans to private firms for infrastructure projects are increasingly turning bad. For example, the RBI pointed out, in power generation, the bids allowed bidders to assume exchange rate and fuel cost risks, without enforcing suitable hedging. When foreign exchange rates fluctuated beyond certain bands, the generation contracts had become unsustainable. And power companies had to seek large scale renegotiation.
In roads, the transfer of traffic risk, known as unpredictable, highly variable and outside the control of the private sector, could have been avoided. Given that the high leverage of construction firms in the road sector amid environmental and land acquisition issues has tempered the private sector’s interest in PPP bidding, measures such as premium rescheduling, cancelling and rebidding of contracts and recourse to engineering, procurement and construction (EPC) contracting has become necessary. Similarly, the perception is that port concessions are designed to charge users more than needed; a number of them have been challenged in courts.
The RBI has brought out how banks have been affected by badly performing private sector infrastructure projects.
While stressed advances of the scheduled commercial banks (SCBs) have declined marginally to 10.0 per cent of the total advances in March 2014 from 10.2 per cent in September 2013, they remain high. Five sub-sectors, namely, infrastructure, iron and steel, textiles, mining (including coal) and aviation services, that account for about 24 per cent of total advances, comprise over half of stressed assets.
Of these, asset quality in iron and steel and infrastructure has worsened most sharply. While share of advances to infrastructure continued growing, albeit slowly (the share of the other four sub-sectors have declined), from 13.5 per cent in March 2011 to 14.4 per cent, in March 2014; infrastructure as a share of stressed assets, has risen sharply, from 8.4 per cent to 29.2 per cent.
This implies that the stress rate of infrastructure, which was much less than the average, is now over twice that of the overall portfolio. Over a fifth of all infrastructure advances are stressed and in stress tests of credit risk exposure to sectors, infrastructure impacts banks most severely on account of potential losses on future assumed impairments.
These developments have two major consequences for the Indian economy. First, since there is a large shortage of infrastructure facilities in India, growth is hampered. Without faster build up of infrastructure, India cannot grow faster and development will be stalled. Poorly performing infrastructure projects will be denied fresh loans in the future and therefore these projects would not take off. Needless to say the development would hurt the economy adversely.
Secondly, infrastructure sector means large investment. If banks refrain from funding these projects, what alternative sources of funding should be sought. The finance minister had made it easier for banks to fund infrastructure and core projects, but banks on their own would refuse to get drawn into such funding. We have not opened up long term debt markets effectively which could provide funds.
But there too one or two bad experiences with infrastructure and core projects would shoo away investors. In the absence of proper growth of this sector, which now has to come mainly from the private investors, India faces a major problem. IPA
Hence, if the pace is to pick up, the non-farm sectors must show lively performance. Fortunately, we are seeing some little signs of life in industrial sector, going by the latest indices of industrial production. But these must be sustained if the RBI prognostications are to run true.
But more importantly, RBI has drawn attention to some ground level hitches, particularly in core and infrastructure areas, which should be taken up by the government seriously.
RBI’s annual report has pointed out how and why private sector infrastructure projects were proving to be non-starters. Defects in contracts have largely rendered these projects unviable and the government should look into revising infrastructure contracts with the private sector.
This issue was pointed out earlier in the Economic Survey. The survey is basically the work of the chief economic adviser in the union ministry of finance. During the tenure of Professor Kaushik Basu, when he was the chief economic adviser, the survey had devoted one full section to what was stated as the micro-economic foundations of macro-economic growth.
It was argued that unless the micro foundations were solid and straightened, overall growth cannot happen. Even if there are spurts in growth rate, the constraints posed by ground level problems work as brakes to growth momentum. The hitches in contracts, for example, hurt infrastructure projects in course of their implementation and stalled them. Thus these call for minute attention and they should be reworked.
The RBI annual report, on the other hand, has brought out that the poorly performing infrastructure and core sector were affecting India’s banking industry as well. With infrastructure projects increasingly going into private sector, many of the projects were funded by scheduled commercial banks. Hence, this issue is also important for banking sector since their loans to private firms for infrastructure projects are increasingly turning bad. For example, the RBI pointed out, in power generation, the bids allowed bidders to assume exchange rate and fuel cost risks, without enforcing suitable hedging. When foreign exchange rates fluctuated beyond certain bands, the generation contracts had become unsustainable. And power companies had to seek large scale renegotiation.
In roads, the transfer of traffic risk, known as unpredictable, highly variable and outside the control of the private sector, could have been avoided. Given that the high leverage of construction firms in the road sector amid environmental and land acquisition issues has tempered the private sector’s interest in PPP bidding, measures such as premium rescheduling, cancelling and rebidding of contracts and recourse to engineering, procurement and construction (EPC) contracting has become necessary. Similarly, the perception is that port concessions are designed to charge users more than needed; a number of them have been challenged in courts.
The RBI has brought out how banks have been affected by badly performing private sector infrastructure projects.
While stressed advances of the scheduled commercial banks (SCBs) have declined marginally to 10.0 per cent of the total advances in March 2014 from 10.2 per cent in September 2013, they remain high. Five sub-sectors, namely, infrastructure, iron and steel, textiles, mining (including coal) and aviation services, that account for about 24 per cent of total advances, comprise over half of stressed assets.
Of these, asset quality in iron and steel and infrastructure has worsened most sharply. While share of advances to infrastructure continued growing, albeit slowly (the share of the other four sub-sectors have declined), from 13.5 per cent in March 2011 to 14.4 per cent, in March 2014; infrastructure as a share of stressed assets, has risen sharply, from 8.4 per cent to 29.2 per cent.
This implies that the stress rate of infrastructure, which was much less than the average, is now over twice that of the overall portfolio. Over a fifth of all infrastructure advances are stressed and in stress tests of credit risk exposure to sectors, infrastructure impacts banks most severely on account of potential losses on future assumed impairments.
These developments have two major consequences for the Indian economy. First, since there is a large shortage of infrastructure facilities in India, growth is hampered. Without faster build up of infrastructure, India cannot grow faster and development will be stalled. Poorly performing infrastructure projects will be denied fresh loans in the future and therefore these projects would not take off. Needless to say the development would hurt the economy adversely.
Secondly, infrastructure sector means large investment. If banks refrain from funding these projects, what alternative sources of funding should be sought. The finance minister had made it easier for banks to fund infrastructure and core projects, but banks on their own would refuse to get drawn into such funding. We have not opened up long term debt markets effectively which could provide funds.
But there too one or two bad experiences with infrastructure and core projects would shoo away investors. In the absence of proper growth of this sector, which now has to come mainly from the private investors, India faces a major problem. IPA
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