The State Bank of India's (SBI) decision earlier this week to not fund interest payments during the infrastructure construction phase is not only a move to manage its exposure to infrastructure going forward, but also a call to think of innovative solutions to finance the construction phase of infrastructure projects in India.
The earlier mechanism, where interest payments were capitalised during the construction phase followed by repayment once the project was commercially operational, will have to change to some extent. We can either progress towards a financing mechanism where an alternative lender provides additional support to the infrastructure project during the construction phase or move towards creating a "construction bank" targeted at infrastructure.
It is important to realise the impact of SBI's decision. SBI and the other public sector banks (PSBs) with short-dated liabilities are simply not equipped to finance long-dated infrastructure assets. In addition, their technical and operational capacity to understand the risks involved in infrastructure financing is also debatable.
From the infrastructure sector's perspective, not being able to capitalise interest payments during the construction phase means new projects will be even harder to execute. For India, it is important that we find solutions that address issues faced by both PSBs and the infrastructure sector. The long-term aim must be to wean the infrastructure sector off PSB financing and yet promote infrastructure creation.
SBI's decision may create an opportunity for specialised lenders to finance the interest payments during the construction phase. For private infrastructure financiers with specialised knowledge, this presents an opportunity to assist in creating financing mechanisms using debt or hybrid structures that will allow projects to finance the interest payments.
The government needs to also start thinking on the lines of creating a construction bank in India. This can look to finance not just the interest payments during the construction phase but also other financial requirements. To take the idea of an construction bank forward, there is the potential to create a quasi-government institution that will take care of the entire construction phase. Infrastructure projects financed by this bank will be auctioned to players interested in operating these projects after the construction phase is over.
This will effectively be an "asset recycling" mechanism, whereby commercially operational assets can be leased out to private capital. A construction bank that successfully creates projects and then leases them to private capital will achieve the dual aim of expediting infrastructure creation and assisting in the flow of private capital into the sector. It can be a game changer.
However, it is important to adopt a gradual approach to the creation of such a bank.
Firstly, the construction bank must have a clear mandate in terms of the projects it will construct. We recommend starting with sectors in which projects will be fully financially feasible. That is, projects constructed can be leased out for 25- to 30-year concessions to private capital for the government to recover the construction cost and a risk premium for the risk undertaken. The aim will be to recycle this capital to build more infrastructure projects.
Secondly, the bank will have to be a central point for the various government departments involved in the process. It will be essential that it expedites the process around infrastructure creation by coordinating between various government departments. This will require the bank to have powers that allow it to manage the approvals process faster. It can add significant value where private capital often struggles.
Thirdly, the bank will have to ensure that it has access to the best "human capital" available to deal with both operational and financial risks involved in the construction phase of infrastructure projects.
Fourthly, it must have a defined corpus of funds. And finally, it should have a well-defined information and risk management system in place. This system will have to be improved as the bank scales up its investments. Essentially, we need to create a template for the working of a construction bank that will eventually help finance much needed complex infrastructure.
It is said "every cloud has a silver lining". SBI's decision is an opportunity for the infrastructure ecosystem to innovate and move forward. Specialised lenders have an opportunity to partake in infrastructure creation. In the big picture, the government must create a variant of a construction bank to boost infrastructure creation in India.
(Taponeel Mukherjee heads Development Tracks, an infrastructure advisory firm. Views expressed are personal. He can be contacted at firstname.lastname@example.org or @Taponeel on Twitter)