Interview: C.P. Chandrasekhar on Indian Development Finance

IUKDPF Research Associate Dr. Jai Bhatia speaks with C.P. Chandrasekhar – former Professor at the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi – on recent shifts in Indian Development Finance.

Professor C.P. Chandrasekhar

JB: How has development finance changed in India since the early 2000s and where do you see it going?

CPC: There has been a dramatic change in the nature of development finance in the period after 2000. After independence India built an elaborated and diverse development finance architecture which had a number of institutions geared to financing large capital-intensive projects with institutions, such as Industrial Finance Corporation of India, Small Industries Development Bank of India etc. In 1991, India began the process of economic liberalisation or neoliberal reform, where development banks such as the Industrial Development Bank of India (IDBI) would receive special assistance or support from the central bank and from the government’s budget so that they were in a position to mobilise resources to support industrial development. Such facilities were not available to the private sector financial institutions. The Narasimhan committee I and II recommended that it is necessary to create a level playing field for the private sector, especially, as the private sector had come to occupy a more important role within the financial structure of the country. Therefore, it was decided by the state that access to special low cost finance which these institutions had was not warranted. Barring, perhaps, in the cases of some institutions which have a special social mandate.

So, after 2000, the Indian government decided that the main development finance institutions, such as the ICICI and IDBI etc. be allowed to enter into commercial banking, through the establishment of the commercial banking subsidiary and subsequently, the original development finance institutions were reverse-merged into the subsidiary commercial banks. These banks now would both undertake commercial banking activities as well as development finance activities. But the whole notion of development finance is that commercial banks cannot undertake investments of certain kinds especially, in large, lumpy investment projects with long gestation lags and so on. Therefore, specialised institutions are needed to close the gap for long term investing. When the distinction between commercial banking and development finance was done away with, the public commercial banks took on the burden of the development financing agenda, and this, over period of time, has resulted in the accumulation of large non-performing assets of loans provided to the corporate sector to finance activities that would have earlier been financed by the development finance institutions. So, that is a dramatic change. 

The question was: how is this going to be resolved? One way would be to provide long-term finance by getting commercial banks to do it and the other would be to try and set up government sponsored but relatively private institutions like the Infrastructure Leasing and Financial Services (IL&FS) company. But due to the absence of due diligence, maybe some malpractice, IL&FS ended up in a situation where, it couldn’t service its debts and went bankrupt. So even an IL&FS-type institutions did not work. Now, we are in a situation where in some sense you can say that development finance – of the kind which is typical of late industrialising countries in general – came to some kind of an end in India in the period after 2000. 

JB: In your opinion, how would you compare China’s and India’s international development finance strategy in terms of availability and accessibility to finance in the kind of trade and investments that each country supports abroad? 

CPC: The perspective underlying the current policy of development finance in India is that a liberalised financial sector in a liberalised economy cannot have specialised development finance institutions. There are institutions which undertake multiple activities, financial supermarkets of some kind, but they shouldn’t be institutions which are protected or supported by the government. 

China Development Bank

In the Chinese case, the big example of development finance in China of course, is the China Development Bank (CDB), the super-bank that was created after 1978, after China had liberalised. The idea was that to be a market economy, then specialised institutions were needed to close the gap for long term finance for capital intensive projects. This is not true only of China. This is true of Brazil – the BNDES was not shut down or converted into a commercial bank because Brazil liberalised. If institutions of this kind, consolidate themselves on the basis of their domestic activity and build the capabilities, then they can use them as instruments in international economic diplomacy. For example, the China Development Bank, the BNDES and the South African Development Corporation – all these are institutions are examples of development finance institutions that subsequently went beyond their borders. Since India doesn’t have or has very few such institutions, it’s not going to be able to operate through these development financeinstitutions. If at all, India is going to follow economic development diplomacy of some kind, it will either have to be through bilateral aid channels or through support for some multilateral institutions, which China also does. It supports the New Development Bank and also de facto controls the Asian Infrastructure Investment Bank. 

BRICS New Development Bank

“India can’t afford to go around splurging in the international arena.”

JB: What would India need to do to compete with China? If India were to come up with a strategy, to compete with China’s development banks, what would India have to do? What would the steps be?

CBC: The question requires a long list of answers. China is a country which has run current account surpluses on its balance of payments and has accumulated large foreign exchange reserves based on its own net surplus earnings. India has consistently run current account deficit, barring a few years, and even though it has some amount of foreign exchange reserves, those reserves are barely in excess of that required to finance the current account deficit. So, it would mean that India would have to borrowed reserves to compete with China. India can’t afford to go around splurging in the international arena.

If India uses money that is implicitly borrowed to undertake international diplomacy, then it is at risk of weakening the balance of payments position. Balance of payments position of a country needs tobe strong, in order to play a role internationally, let alone compete with China. India may not want to operate on the basis of a development aid route because significant investments in most developing countries including investments in India’s neighbours, occurs through the private sector.Normally, bilateral trade and investments goes from state to state. Having development financial institutions allows a country to actually directly interact with the private sector and with the public sector corporations. The problem is that India had such institutions which should have diversified in this direction, but India has lost them, so India will have to rebuild them. 

India’s %GDP growth
Source: World Bank

In addition, the economy needs to be strong. There was a period between 2003 and about 2012, barring the global financial crisis, when India was doing quite well and registering very high rates of growth but from about 2015-16 there has been a sharp decelaration in growth. This decelaration gathered momentum even before the COVID crisis. Now, with the COVID crisis, there have been the most stringent lockdown, so India’s economy is weakening. Without foreign exchange reserves, India does not have the means to deploy itssurpluses in the private sector in countries with whom it wants to engage in economic diplomacy with.

JB: To what extent does the Export Import Bank of India represent the Indian government’s effort to promote international trade and investment abroad?

CPC: Of course, it principally is engaged in activities which have to do with the promotion of Indian trade and trade financing of different kinds. 

It is a bank which promotes Indian trade but that doesn’t make it a classic development finance institution. It is true that as part of this process of promoting Indian trade. It has tried to support investments abroad which can help expand India’s global footprint but that is not its primary role. 

JB: Given the condition of development finance in India, where would you say is the future of International Development partnerships that India can engage in?

CPC: Well, I think that India is developing partnerships – until the changes are made, when India creates a financial architecture that can serve as an instrument for international economic diplomacy, until such time I suppose development partnerships will be built on the basis of state aid. India could modify the state aid package to finance private activity in some of the partner countries, maybe with or without government guarantees. India is undertaking such financing and providesdevelopment aid to support infrastructure in countries in which Indian business have a presence. So, Indian development partnerships will be mediated by the state, as the principaldevelopment partner in which state facilities other agents who can become development partners andthose agents are likely to be from the private sector and some public sector corporations.

“How big India’s development partnerships will be will depend upon how well India does.”

JB: Will India’s investments in development projects in Africa primarily be driven through the Indian private sector? And do you think that is sustainable in the long run?

CPC: If the Indian economy is doing well, and if the Indian private sector is doing well, then there are areas in which Indian business can undertake investments and the government will try to facilitate such investment by getting the public banking system to back Indian companies. The state uses the fact that it has a public banking system which is the dominant part of the banking system in India and uses it to support the private sector. Finally, it also depends on how the economy and these private companies are doing because very often the private companies’ strength comes from the fact that that they have a strong base in the domestic market. If there is any sign that that base begins to weaken then they would shift back their attention to the domestic markets. If it is a development partnership, then it has to be with agents who have a strong base and strong roots in a partner country and have state support. How big India’s development partnerships will be will depend upon how well India does.

Dr Jai Bhatia is a research associate at the India-Development Partnership Forum. Her research examines various aspects of Indian development finance.