A wary Reserve Bank of India will likely enforce a rule that could dampen the spirits of India’s capital expenditure momentum, a highlight of the Narendra Modi government’s tenure at the Centre.
RBI has issued draft guidelines asking lenders in India to increase their provisioning for infrastructure projects which are under construction and has asked them to ensure strict monitoring of any emerging stress.
In essence, provisioning entails lenders allocating a specific portion of their balance sheets as reserves to cover expected future losses.
However, banks and experts are now worried that these guidelines could affect the momentum India’s infrastructure projects have seen in recent years. This is because a higher provisioning rate could increase interest rates and negatively impact India’s capital expenditure momentum.
Capex drive has emerged as one of the biggest talking points of the Modi government’s second tenure, with the NDA government investing heavily in capital projects that are seen to have positive multiplier effects on the economy. Finance Minister Nirmala Sitharaman allocated Rs 11.11 lakh crore towards capital expenditure for FY25, up 17 per cent from the revised capex estimate of Rs 9.5 lakh crore for FY24.
RBI’s draft norms will be implemented after lenders provide their feedback to the central bank by June 15.
India’s private sector revival under threat?
Banks are poised to advise the central bank against the sharp rise in provisions, contending that it could impede the momentum that has pushed India to become the fastest-growing major economy in recent years amidst global uncertainty, ET reported on Wednesday.Banks are arguing that higher provisions for ongoing projects could send the costs higher, which could in turn lead to delays and stressed loans.
The Modi government’s capex drive was in particular seen to give a positive fillip to India’s private sector activity which has seen muted growth in recent years. India Ratings in a recent note highlighted that on the capex front, a new cycle was in the offing for the private sector, as seen from the increase in the project loans sanctioned by lenders.
However, RBI’s draft norms force one to temper their expectations. The draft norms are punitive toward incremental and existing project lending, Nomura said in a note.
“The sharp increase in provision for standard assets to 5 per cent for all fresh and existing project loans in under construction will have a direct impact on the cost of debt. Consequently, this will dampen the bidding appetite from infrastructure developers in the medium term,” CareEdge wrote in their note.
Why is RBI pushing for these norms?
Bankers ET spoke to were not sure why RBI felt the need to increase the provisions this sharply, especially given that banks’ results show that fresh slippages were lower than recoveries.
“It is very difficult to see what the logic is, or what could be a fair level, for provisions. It could force the handful of banks which do infrastructure lending to rethink lending to this sector,” one banking executive told ET.
However, there is historical precedence for RBI’s action, given what happened in the 2010s.
Beginning in 2012-13, Indian lenders experienced a notable increase in non-performing loans, primarily due to the souring of numerous infrastructure-related borrowings following the global financial crisis of 2008.
Extensive project delays and overly optimistic revenue forecasts resulted in significant defaults, causing lenders to become wary of the infrastructure sector.
Given India’s current thrust on projects in the infrastructure sector, RBI seemingly wants to be one step ahead of the curve as a matter of prudence.
What RBI proposal for tighter project finance rules will mean for REC, PFC?
What are RBI’s latest guidelines on project financing?
With financing of project loans in mind, RBI’s latest proposal means banks will have to set aside a provision of 5 per cent of the entire loan amount when the project is in its construction phase.
Once the project becomes operational, the rate can go down to 2.5 per cent and 1 per cent once it starts generating cash sufficient to cover repayment requirements.
Project loans that were not overdue or stressed so far attracted a provision of 0.4%, as per a 2021 circular available on the RBI’s website.
The central bank said lenders should monitor the build-up of stress in projects on an ongoing basis and initiate resolution plans well in advance.
