Financial Capacity for Infrastructure and Corporate Expansion

Source-This post on Financial Capacity for Infrastructure and Corporate Expansion has been created based on the article “Banks and companies can now fund India’s next growth cycle” published in “The Indian Express” on 22 July 2024.

UPSC Syllabus-GS Paper-3- Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.

Context– In the last decade, companies have tripled their capacity for funding capital expenditures due to lower debts and increased profits, according to CRISIL. The banking sector, strengthened by reduced bad loans and timely recapitalization, is now robust in lending.

What are the reasons behind this increased ability of corporates and banks to fund capital expenditure?

1) Corporate Financial Health: Factors such as increased cash accruals, reduced leverage (median gearing), and improved working capital cycles have strengthened their ability to undertake capex. In terms of nominal GDP, capex ability has increased from 3.8% a decade ago to 5.2% now.

2) Banking Sector Reforms and Performance

A) The banking sector has improved significantly with reduced non-performing assets (NPAs) and better capital adequacy ratios. This has also been supported by government funding for public-sector banks and private banks raising capital.

B) Clearing up balance sheets through write-offs and maintaining higher provisioning coverage ratios has restored trust in their ability to lend.

3) Financial Innovation and New Funding Avenues: –

a) Infrastructure Investment Trusts (InvITs): Since 2017, more than 19 InvITs have been set up, managing assets worth Rs 4.9 lakh crore, half of which is financed through debt. InvITs have attracted equity and debt from both domestic and international investors for infrastructure assets. This has enabled developers to monetize revenue-generating assets and deploy capital into new projects.

b) Real Estate Investment Trusts (REITs): REITs, like InvITs but for real estate, manage assets valued at Rs 1.4 lakh crore, with one-third financed through debt.

C) Restricted Groups (RGs): This innovation provides advantages like diversification, debt control, and cash flow protection. CRISIL Ratings has rated 13 RGs, including 11 in renewables, with a total rated debt of Rs 14,000 crore.

d) Sustainability-linked and Green Bonds -These instruments are becoming more popular because they focus on reducing climate risk. Green bonds are financing renewable energy projects and are preferred by international investors.

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What should be the way forward?

1) Factors to Monitor -Companies should closely monitor factors such as interest rates, global uncertainties, excess global capacity, and uneven recovery before committing to large-scale spending.

2) Deepening the Bond Market- The domestic corporate bond market needs to be deepened to become a significant funding source.

3) Structural Improvements– Implementing structural improvements to attract patient capital investors such as insurers and pension funds. This may involve allowing investments in lower-rated bonds (below AA), raising exposure limits to the infrastructure sector, and adopting expected loss ratings.

4) Infrastructure Financing -The corporate bond market needs to enhance its capacity and risk appetite to facilitate take-out financing for operational infrastructure projects.

5) Expanding Credit Capacity -There is a need to create more credit capacity for funding capital expenditures in emerging sectors like green energy.

Question for practice

What are the reasons behind this increased ability of corporates and banks to fund capital expenditure?