Evolution and Growth of the Indian Economy and the Banking Sector since Economic Liberalization

The Indian economy is the seventh-largest in the world by nominal GDP and the third-largest by purchasing power parity (PPP). The initiation of economic reforms in the 1990s saw India gradually breaking free of the low growth trap which was euphemistically called the “Hindu growth rate” of ~3.5 per cent per annum. Real GDP growth averaged 5.7 per cent per annum in the 1990s, which accelerated further to 7.3 per cent per annum in 2000s. India has now emerged as one of the largest and fastest growing emerging market economies in the world. The banking sector in India has also grown and evolved alongwiththe growth in the economy. The total credit to the private sector provided by the banking sector (as % of GDP) has grown from a level of 23% prevailing in 1991 to over 52% now. However, the country’s banking sector still has a long way to go as compared to other large developing economies such as China as well as the developed economies as may be seen in chart below:

Source: World Bank

The growth in the advances of Indian banking sector in the recent past has been characterized by the high growth in advances to infrastructure sector. The infrastructure exposure of banks has grown at a CAGR of over 22% over the past 6 years and now forms over 15% of the total bank credit as shown below:

Source: RBI

Significant increase in infrastructure funding poses concentration risks for the banking sector.

Stressed Assets – Biggest Challenge before the Banking Sector

The Indianbanking sector is currently facing the problem of increased level of Stressed Assets, comprising of both Non-Performing Assets (NPAs) as well as Restructured Assets. The level of Stressed Assets in the banking sector has increased significantly over the past few years and stood at 10.7% of the total advances of the banking sector as on September 30, 2014, which translates into total stressed assets of ~Rs. 6 trillion in the banking industry. Infrastructure sector is the single largest contributor to the stressed assets as shown below:

Source: Financial Stability Report, RBI, December, 2014

As seen in the chart above, while the share of Infrastructure Sector in the total advances is 14.8%, it accounts for 30.7% of the total stressed assets. Therefore, in order to understand the reasons for the increased stressed assets in the banking sector and come up with remedies for the same, it is imperative to understand the problems plaguing the Infrastructure sector and devise suitable solutions to address them

Stressed Assets- Key Reasons
The reasons for the high level of stressed assets, especially in the Infrastructure sector, are not far to seek. The major reasons for the high level of stressed assets are identified below:

  1. Promoter related issues:Over the last few years, several business groups have made significant commitments towards large scale projects in the infrastructure sector, without the requisite financial capacity of arranging for the required equity. Consequently, these projects are stalled for want of funds. The leverage ratios of India’s top 500 borrowers is at the highest level since 2004 as may be seen below:

    Source: India Ratings, Dec 2014
    Some projects also saw aggressive bidding from the developers, and consequently they have turned out to be unviable
  2. Land acquisition: Land acquisition has been a sensitive subject and a major roadblock. Several projects have stalled over land acquisition issues, primarily following resistance from local communities and litigations.
  3. Environmental clearance:Many projects are delayed by the need for environmental clearance. This reduces project developers’ and financers’ confidence about a project’s viability. The lack of clarity is seriously dampening project execution and implementation. Projects are mostly held up because of the procedural complexities.
  4. Other issues:Non-receipt of or delay in obtaining statutory approvals from the government (central, state and local) has been a major obstacle. Several power plant projects have been delayed and some operating power plants are running well below capacity on account of delays or non-receipt of approvals. These include continued delays in obtaining statutory permits for captive coal blocks. Compounding this, there is uncertainty about coal pricing and power tariffs, and weak off-taker quality (the precarious financial conditions of state utilities)
  5. Availability of funding: The above mentioned delays in land acquisition and in approvals for projects have impacted project funding. The delays lead to major time and cost over-runs, thus impacting the viability of the project. Negative macro-economic conditions have also dampened project funding.

Stressed Assets - Consequences
The high level of stressed assets has severe consequences for the economy in general and the health of the banking and infrastructure sector in particular. On account of the unpleasant experience, the banks have now turned cautious in lending to the infrastructure sector, thereby choking the flow of funds which is vital for infrastructure development and economic growth.The increased level of stressed assets impairs the ability of the banks to provide fresh loans, which is critical for sustained economic growth. It is pertinent to note that the total stressed assets of the banking sector constitutes a significant portion of the total market capitalization of all the banks. Moreover, as most of the banks in India are owned by the Government, the high level of impaired assets necessitates infusion of additional capital by the Government in order to maintain their capital adequacy, which in turn may have serious implications on the public finances and fiscal deficit of the Government. At a larger macro level, if this problem is not addressed, it has the potential of threatening the stability of the Indian financial system and the sovereign credit rating of the country, as a result of which the country may lose its appeal among the international investors at a time when foreign capital is critical for economic development

Remedial Measures needed to tackle the problem
As we have seen above, the problem of the stressed assets in the banking sector is synonymous with the problems plaguing the infrastructure sector. There are certain remedial measures which are commonacross sectorswhile certainmeasures may need to be devised to address the issues which are unique to aparticularsector.Some of the remedial measures for addressing the problem of stressed assets are described below:

  1. Ability to change management:Banks should have the ability to change ownership and management in case of a non-performing or non-cooperative promoter. For this to be successful, banks would also need some form of legal immunity from lawsuits filed by the outgoing promoters which would otherwise have the effect of inordinately delaying the process of changing the management. The banks may appoint a professional management team with requisite experience in that particular industry to manage the operations of the company. This would also operate as an incentive to the promoter to ensure that the Corporate Debt Restructuring (CDR) package is complied with and that the forum is not misused by unscrupulous promoters. Banks should be encouraged to act as a consortium and act collectively, particularly with respect to obtaining pledge of promoter’s shareholding as security, and facilitating change in the company. This shall also require change in the existing regulations which disincentivise an individual bank from taking pledge exceeding 30% of the borrower’s equity capital. This is in line with international trends where lenders and vulturecapital funds typicallytake over the debt of the company and displace the existing management
  2. Facilitating the setting-up and flow of capital to Stressed Asset Funds: Several projects which are inherently viable are stuck on account of lack of last mile funding as the promoters may be unable to infuse the required equity to complete the project and make it operational. Such projects may need mezzanine funding for completion. In view of this, a regulatory framework needs to be developed which shall facilitate the setting-up and flow of capital, both domestic as well as foreign, into Stressed Assets or Mezzanine Funds. The regulatory framework should provide adequate tax and other incentives for such funds, so that they may play a vital role in operationalizing the stranded projects or projects operating at sub-optimal levels on account of lack of equity funding. In order to be successful, such funds would need priority over the cash flows of the project.
  3. Legislative reform in the form of Insolvency andBankruptcy Laws in line with international practices: India needs suitable Insolvency and Bankruptcy Legislation in line with international practices, which can protect the interests of the creditors. The creditors should be capable of appointing an Administrator to take over the affairs of an insolvent company. Such protection is required for efficient functioning of capital markets and continued availability of capital for investment. In the absence of a collective procedure in the form of a corporate insolvency regime, the creditors may have incentives to run on the company’s assets in the event of insolvency. By providing adequate protection to creditors in insolvency, the law incentivizes them to continue providing capital to businesses and lowers the cost of debt capital for companies in general
  4. Extension of the concession period in case of Public Private Partnership (PPP) projects:PPP projects in the infrastructure sector are given out for a fixed concession period which typically range from 15-25 years. Given the issues plaguing the infrastructure sector, several PPP projects have undergone a significant time and cost over-run, thereby rendering them unviable within the pre-determined concession period. In such cases, the government may activelyconsider ways and means of suitably extending the concession period by say, 8-10 years, thereby enabling the project to recover its costs and repay the debt. However, this should be accompanied with adequate controls to ensure that this is not misused by promoters
  5. Regulatory Relaxations:Infrastructure projects are typically financed by debt which may be as much as 70-80% of the project cost.Any delays faced in the implementation of these projects result in a significant cost over-run arising primarily from the Interest During Construction (IDC), for which additional debt funding is required. Consequently, the project is not able to service the higher loan burden, thereby permanently impairing the viability of the project. In view of this, it is essential to have a regulatory framework which can support such stressed projects by facilitating debt funding at a lower interest cost (which may, if need be, below the minimum lending rate or base rate of the bank) or by facilitating conversion of a portion of the debt into equity/equity like instruments. The lending banks may recover their returns at a later date when the operations of the project have stabilized and it is generating cash flows.
  6. Power Sector:Power is the single largest sub-sector within the infrastructure sectorand accounts for a major share of stressed assets in infrastructure sector. In view of the unique complexities and issues facing the power sector, certain specific measures which address these issues are required. Some of the remedial measures for the power sector are described below:
    1. Reforms of state power distribution utilities: Power distribution in India is largely controlled by state utilities (discoms) which are in poor financial health on account of highly subsidized and low level of tariffs, high Aggregate Technical & Commercial (AT&C) losses arising on account of power theft, faulty and obsolete metering system, etc.As a result, while on the one hand power generation plants are idling on account of lack of power offtake, the discomsare not in a position to enter into long term Power Purchase Agreements (PPAs) owing to their poor financial position.Further, the payments from discomsare often delayed leading to piling up of receivables and consequent liquidity crunch for the generating companies.Therefore, reforms in power distribution are imperative for ensuring long term viability of the power sector. The setting of tariffs for discoms should progressively be made market linked, by having an independent regulator with authority to fix tariffs,so that political interference is minimized. In addition, a framework for providing suitable incentives for reduction in AT&C losses is required.PPP models which have demonstrated success in this area, eg. awarding a distribution license area to a private developer as a Distribution Franchisee may also be implemented
    2. Reforms in Coal Mining:Coal based thermal power accounts for ~60% of the installed power capacity in the country. The thermal power plants have been facing issues of inadequate and erratic supply of coal, resulting in sub-optimal and increased cost of generating power. Coal mining in India is largely a monopoly with Coal India Limited (CIL). CIL’s output has stagnated and is not able to meet the increased demand from power sector. Therefore, it is imperative to open up the coal sector to facilitate merchant mining of coal by the private sector. The government has initiated steps in this direction by auctioning the coal mines to private players for captive use. However, the reforms need to be deepened further by way of auction of coal blocks for merchant mining and sale of coal by private participants, both domestic as well as foreign, at market determined prices. This shall facilitate introduction of international best practices in the areas of mining technology and environment conservation and give the much needed boost to output.
  7. Roads: Road sector is the second largest constituent of infrastructure sector after power. Several road projects are stalled on account of land acquisition related issues or inability of the promoter to infuse funds to support the project. The measures suggested to address these issues are as follows:
    1. Land acquisition Reforms: The regulatory framework for acquisition for land and right of way (RoW) needs to be streamlined to facilitate to avoid time and cost over-runs. Road projects under PPP model should be bid out only when land acquisition is complete, so that the project developer and the lending banks do not face the risk of delays and the resultant cost over-run on account of land acquisition related issues. The government has already initiated steps in this regard by introducing a new land acquisition bill which seeks to address some of the issues pertaining to land acquisition.
    2. Facilitate sale of road projects:Currently, the project developers face various constraints in selling their road assets. The sale is subject to various restrictions and requires consent from NHAI, in case of projects bid out by NHAI. Often, the developer is over-leveraged and may not have the financial resources to support the project during its initial period. Allowing the existing leveraged developer to sell his road asset, including under construction projects, to a stronger player who may have the financial resources and the ability to complete and operate the project may be beneficial for all stakeholders. While the leveraged developer may be able to take steps towards de-leveraging by asset sale, the stalled road asset may pass into stronger hands and start generating cash flows after completion.


The infrastructure sector in India is still in an early stage of development. The importance of infrastructure development in achieving long term sustainable economic growth cannot be over emphasized. The sector is an important constituent of the banking sector and requires large amounts of investments. Therefore, it is imperative to address the issues facing the sector, in order to address the stressed assets problem of the banking sector and at the same time facilitate the flow of capital for infrastructure development for ensuring a high rate of economic growth. The above mentioned remedial measures shall go a long way towards ensuring the same.


Jignesh Shah

Chief Investment Officer of IL&FS Infra Asset Management Limited (IIAML), Mumbai
IIAML is the AMC for IL&FS Infrastructure Debt Fund (IL&FS IDF), the first IDF – Mutual Fund in India.


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