Central bank move hurts India’s infra hopes

The decision to ban banks from buying infrastructure bonds complicates the new government’s efforts to raise up to $10bn in the current financial year.

The Reserve Bank of India (RBI), India’s central bank, has banned the country’s financial sector from purchasing bonds issued to pay for infrastructure works.

The move is a blow to the government of Narendra Modi, who won elections on a landslide last May after pledging to revitalise India’s flagging economy through an ambitious infrastructure push.

In order to meet with the vast funding needs such a programme would require, the government in mid-July exempted banks from holding compulsory reserves against infrastructure bonds, in effect allowing them to buy and hold the securities off their balance sheets.

The government was aiming to raise between $8.3 billion and $9.9 billion via infrastructure bonds in the current financial year.

But the RBI balked at what it described as the likelihood of “circular trading”, whereby banks would have agreed to buy bonds issued by other lenders. The institution did not think its decision would lumber infrastructure funding in a significant fashion, hopeful as it was that investors such as insurers, pension funds and mutual funds would show unabated appetite for infrastructure bonds.

Yet analysts underlined how keeping banks out of the secondary market will likely weigh on the bonds’ liquidity, shaking the confidence of other would-be institutional investors in the instruments.

“Banks are the market makers, the largest investors and underwriters of corporate bonds. If banks are not allowed to invest in these senior infrastructure bonds then other investors like mutual funds would be sceptical buying them since they wouldn't be sure of being able to sell them if liquidity need arises,” said Shashikant Rathi, head of investments and capital markets at Mumbai-based Axis Bank.

The move seems to strike a jarring note with the most optimistic Indian economic scenario in years, with a number of players ready to bet big on the opening up of the country’s infrastructure market.

In addition to Indian conglomerate Piramal Enterprises, which committed $1 billion to a joint infrastructure platform launched with Dutch pension APG Asset Management in July, local firms IL&FS, L&T Infrastructure Finance and IDFC Alternatives are looking to collect a total of $2.5 billion to invest in the asset class in the coming months.

The International Finance Corporation (IFC) is aiming to raise a similar amount – on the domestic capital markets – over the next five years to help plug India’s infrastructure gap.

“Vibrant capital markets provide critical access to finance for the private sector and bonds offered under IFC’s rupee financing program, offer a safe investment alternative for domestic pension funds and other investors, while mobilising capital to address India’s infrastructure needs”, said IFC’s chief executive Jin-Yong Cai.