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'Infrastructure spending will be hit'
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December 12, 2008

Given that banks will have a big asset-liability mismatch if they lend too much to infrastructure, and that equity markets are in poor shape, it is obvious infra-spend will take a hit. But just how big a hit? Rajiv Lall, managing director of Infrastructure Development Finance Corporation (IDFC [Get Quote]), outlines the contours of the problem to Shobhana Subramanian while explaining what the government is trying to do about it. Excerpts:

An infrastructure spend of around $515 billion has been envisaged for the 11th plan, will this spending happen?

This is unlikely to happen not because there isn't enough money but because of the way you put it to work. The private sector is expected to come up with 30 per cent of this amount but where is the private sector going to get it? It's not that we don't have the savings but, right now, it looks like the money has to come from the banking system and three or four NBFCs- this is the debt component.

Now, does the banking sector have  the capacity to absorb this kind of spending given that in the last 3-4 years it has grown its infrastructure loans very rapidly? Also, does the regulator want a disproportionate burden falling on the banks -  there could be an asset-liability mismatch since the deposit franchise is short-term whereas you lend long -term.

There is also a refinancing risk, some of which they can take, on the grounds that around 25 per cent of deposits are CASA, which will keep getting rolled over and so, against that, they can safely lend for 8-10 years. Coventional wisdom has it that the equivalent of between 15 and 20 per cent of a bank's liabilities can be lent as long-term assets. If you include housing and infrastructure, we're pretty close to that limit. If we have to meet the $515 billion target, banks will need to lend a significant part of their future deposits infrastructure, and that may be difficult.

So will the public sector do most of the spending?

The public sector has the money; it's no accident, that the world over, infrastructure is developed by the public sector. But, elsewhere, there has been a fair degree of private sector financing because of the complex culture of markets�the array of institutions goes beyond insurance companies and pension funds. You have a bunch of hedge funds with different risk appetites that can participate. So though housing risk may originate in the banks, it is transferred through financial instruments to other players so that the risk is not concentrated in the banks. But today we don't have that kind of a complex market and investors to make this kind of risk transfer possible; in addition, because of the global crisis, this mechanism itself is being discredited. So it becomes that much harder to expect our system to fund this requirement in a way that does not lead to risk concentration problems.

So, what's the solution?

Well, there are two or three options. We will do it but we will take unnecessary risks, the second is we won't do it and the third is that the government will step into the breach. We've been spending roughly $30-40 billion a year but the run rate could slow down. The other problem is that the private sector needs to raise equity capital but that option is now limited and so we will lose time. Even if we spend two-thirds of the targeted amount, it would be an achievement.

How much will the Rs 100 billion refinance from IIFCL through the issue of tax-free bonds help?

It will help because refinancing mitigates the asset-liability mismatch of banks and, therefore, their capacity to do infrastructure funding goes up. It's an important initiative.

Do you believe project closures could be delayed because of shortfalls in equity contribution from sponsors?

Yes, it will take a little more time depending on the market and how quickly companies come to their senses about their equity valuations. It's happening fairly quickly actually, people are starting to negotiate. Six months back no one wanted to talk.

Are any projects achieving financial closure? Bidding for big power projects like the 4GW Tialya ultra-mega power plant and the 2GW Bara seem to have been delayed yet again.

There is a slowdown, it's patchy, but closures are happening. Some really huge projects are delayed -maybe those that cost Rs 10,000 crore (Rs 100 billion) and more. But the expansion of towers for telecom, for instance, is taking place. And we're expecting the bidding for 3G spectrum to happen-that will require a lot of money. The 3G bids will be lower than what could have been expected a year ago. The bidding for the Hyderabad and Mumbai metros too seems to be going ahead.

So how much growth will we lose out on because of the delays?

We were growing at 9 per cent. I don't think we can prevent that coming down to about 6 per cent.

Will the additional 78,000 Mw  of power come up in the eleventh plan?

Even if we get 50,000 Mw, that'll be a huge achievement.

Does IDFC have plans to raise equity?

As a contingency measure, we had  taken an approval from our shareholders at the AGM. But we're not planning to raise capital. Our capital adequacy is 22 per cent, all of it Tier I.

Will delays in projects mean that IDFC's loan growth will slow down from over 50 per cent CAGR in the last two years?

We are slowing down. It's the easiest thing to give people money, but the risk perception has changed. Also, we had anticipated that it may be difficult to raise capital and we want to stay adequately capitalised. This year the growth will be sharply lower, at least half of last year's growth. But in 2009-10, if the macro-environment stabilises, it should pick up.

How is the AMC business panning out?

The AMC business has been a real challenge with the industry going into a tizzy just about a couple of months after we got into it;in that sense the timing couldn't have been more interesting. But not to make light of it, the bet we took was twofold. The first that we want to be in a fee-based business that won't suck up too much capital.

Also, it should serve as a platform, sooner rather than later, for us to launch a new generation of products that allows us to tap into retail savings to fund infrastructure - not mutual funds but some kind of infrastructure REITS. The idea was to find a balance in our business model. In the last three or four months, while the mutual fund pie has been shrinking, our ranking has gone up. But yes, financially to sweat the capital that we deployed for this acquistion will take more time than anticipated.

What's your view on real estate prices?

I think prices should come down 20-30 per cent from these levels.

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