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Post-Covid: Can multilateral development banks drive economic recovery in India?

4 MIN READOctober 14, 2020

Resilience of Indian Markets

The Indian GDP has contracted by 23.9% in Q1 with the yearly figures likely to be in single digit.  It is essential to understand how the Indian economy has been able to sustain the lockdown. With almost everything coming to a standstill for a period of three months the figure of 23% doesn’t look that bad.

The economy has witnessed small businesses transforming their business plans to move online as well as shown resilience as they weathered through tough times. The employment levels have also gone back to pre-covid levels indicating a stronger resilience by the economy.

The Multilateral Development Banks (MDBs) believe that an impact can be delivered through support to various companies in varied sectors. There is significant growth expected specially in infrastructure providing creating potential for large systematic impact. The huge scope for financial and product innovation in the Indian infrastructures with the workforce with a strong skill is a budding opportunity.

MDB Financing in India

The role of the MDBs in addition to providing finance is to be the first risk takers in the market to provide instruments that can help other institutions to be risk averse. The focus of MDBs at the moment is towards unlocking liquidity, strengthening NBFCs, and enabling financial innovations.

Uplifting MSME

The credit rating of the MSME by itself is not good enough for them to get lenders to install green solutions (viz. installing solar rooftops). The MDBs are looking to develop a product that can result in generating say 9$ for every $ by the MDB as well as increase the credit rating and garner investments from large banks. The focus on MSME sectors will help in job creations and bring back employment in the informal sectors and to create an economy where other FDIs/ FIIs can move in. With an expectation of about 1/3rd of MSME likely to face financial distress post the pandemic, focus of MDBs towards MSME will help the sector go a long way.

Acceptability of borrowers towards ESG

ESG plays a very important role for all kinds of premier financiers both equity and debt. The evolution in India on the ESG front has been significant in recent times. There has been significant systematization of collaboration among the government agencies and digitisation of ESG files which indicates a significant progress, providing comfort to the MDBs to undertake more financing. The expertise of ESG in the renewables sectors has been spreading across the newer sectors such as logistic, e-connectivity and greater all-round understanding has been developed.

Initially there was a lot of pushback from the borrowers on the ESG terms, however lately the borrowers themselves have become open to such terms as they have noticed the increase in the value of the company. Some borrowers have undertaken the efforts to get trained professionally for ESG to better equip them. Shift from what law says towards voluntary adoption of ESG has been significant.

The problem that remains is that ESG covenants in the agreements create challenges resulting in a bottleneck from the perspective of finalizing covenants and timelines for completion. Streamlining of ESG is important for faster adoption of ESG norms in India.

In recent dealings by MDBs in the transport and ports sector, they have witnessed greater acceleration making the outlook a lot more positive for undertaking investments by the MDBs.

There however still remains a room for improvement on the procedural front and a few selected spaces.

Creating confidence in projects

MDBs are partial to NTPC and SECI projects, if they invest in state projects, they are likely to charge a premium. This is purely due to the difference in the level of bidding by the state projects and projects by central agencies such as NTPC and SECI.

To get the state bids at par with the bids by NTCP / SECI the MDBs in one of the recent project have developed a 3-step process to be put in place – (i) letter of credit by ministry (ii) funded 6 month escrow account to account for possible defaults (iii) state government guarantee for the project. This helped attract international investors at a record low price.

Solutions for the Indian Economy

The last six months have resulted in a huge loss of consumer confidence due to temporary job losses and reduced purchasing power. One of the priorities of the government should be to support the livelihood of displaced workers and provide them opportunities in the villages or assist them in getting back to the cities. The agricultural reforms in the past six months would help with that. The green stimulus can be provided through generating employment for the migrants that have returned to their native places.

Possible Government Reforms For MDB Financing

The critical concern faced by the government is that the pre-Covid 8-10% deficit in the availability of financing is likely to worsen. This requires grave efforts to help bridging the gap and reduce the deficit. The focus of the government should be on creating the underlying soft loan and concessional facilities, providing technical assistance, involving an explicit guarantee mechanism. Government is looking at ways by which MDBs can have more skin in the game; e.g. with partial enhancement or project guarantee, instead of full risk borne by the government.

One possible solution is to substitute the MDB financing to finance government portions of grants through a suitable PPP model that will help leverage financing available with MDB. Rather than a complete financing by MDB the authorities should be mandated to finance the grant portion and get private sector investment. Further, the government is looking at modifying RBI norms to create separate guidelines for the MDBs by creating a single-window clearance that is available to SWF and pension funds.

How to better structure and channelize MDB financing is the major challenge for the government. Allocating impactful greenfield projects to MDBs along with placing excess emphasis to the pre-bid requirements i.e. land clearances before the bid is placed would help attract investment in infrastructure projects. The projects typically financed through the MDB have fairly good implementation standards; however when a similar project is being financed by the government or a private sector, the standards aren’t quite up to the mark. Adopting the learning from MDB financed projects into non-MDB financed projects will have a cascading impact resulting in more MDB financing in India. The kind of support that can be brought in by the MDB depends on the development trajectory of the country itself.

Concerns around financing from MDB

Financing from MDBs has a long timeline due to their lengthy standard contractual terms. The structural aspects looked at are the timing of disbursements. As an aftermath of Covid-19, the companies are looking for liquidity and hence they will be looking if the process for disbursement can be streamlined through contractual terms and relook at some clauses (financial covenants, providing of information, etc.) MDBs also require counter guarantee to be taken from the government. Giving a name by the MDB to a project warrants long contractual terms for the protection of their interests.

In the current scenario where the banks are unable to finance for infrastructure projects obtaining financing from MDBs has become the focus for the infrastructure projects. 

Outlook for the years to come

The next 5 years bring a great potential for infrastructure projects in India. The government has been undertaking efforts in structuring optimal solutions for finance as well as commissioning them in an expedited manner.  In the MDBs’ allocations a critical space has been given to the infrastructure sector with the intent of helping the government move along on the development path and add to the significant progress that has been made already up to date through digitisation, e-governance, etc. Transport section is being seen as the major thrust area in the near future by some MDBs. India continues to be the largest exposure globally for various MDBs as they continue to bet on the growth in Indian economy.
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