Let’s return to development banking
Development banks played a paramount role in the economic growth of countries. The rapid industrialisation of Europe is owed to institutions such as Credit Mobilier in France, and KfW in Germany which provided capital as also entrepreneurial skills and technological expertise. In the US, War Finance (1918) and Reconstruction Finance (1932) corporations funded railroads, airlines and exports in addition to the war effort. Development banks made huge contributions to the rapid growth of postwar Japan (Japan Investment Corporation), the transformation of Korea (Korea Development Bank), the rise of China as an economic giant (China Development Bank), and Latin American leader Brazil (BNDES).
These banks also extended useful services such as in-house technical expertise, underwriting new capital issuance and creating confidence in other lenders. They performed a counter-cyclical role to ensure investment flows even during economic downturns and actively supported regional integration and the internationalisation of domestic companies. The focus is now on promoting sectors such as green finance, new technologies, SME development and startups.
Development banks formed the central piece of growth strategy in India too. Soon after independence, the institutional framework for development banking began — IFCI (1948), IDBI (1964), IIBI (1972), NABARD and EXIM Bank (1982), SIDBI (1990), etc. The private sector got its due place with ICICI in 1955. In 1952, SFCs came into being followed by refinancing institutions to promote rural electrification, housing and urban development. These efforts paid off well as, according to a recent UNCTAD study (December 2016), development banks loans which formed 2.2 per cent of the gross capital formation in the early 1970s reached 15.5 per cent by the early 1990s.
Reforms, however, altered their pace of growth. The Washington Consensus that guided reforms have put private markets in the forefront. To overcome the inefficiencies that dogged development banks at that time, wide-ranging reforms in stock markets, foreign capital flows, ownership norms, and entry of private and foreign banks were brought in to bolster the private local markets. Accordingly, ICICI in 2002 and IDBI in 2004 converted into commercial banks. The outcome, however, fell far short of requirements. New capital issuance remained lacklustre, private capital veered towards the pursuit of high valuations and a domestic corporate bond market struggled to develop, all of which left a telling effect. The UNCTAD study notes: “As a proportion of the financial system as a whole, between the early 1970s and late 1980s, their loans (development banks) accounted for over two thirds of total disbursals. Between financial liberalisation in the early 1990s and early 2000s, this share declined to 30 per cent; after 2004, it declined further, to 1.7 per cent.”
If it’s the post-90s Washington Consensus that restricted development banks, ironically it is the North Atlantic financial crisis in 2008 that reignited their need. A recent IMF paper (2016) noted, “the initial hopes that the privatisation wave of the 1980s would fuel a private sector funded greenfield infrastructure investment boom have fallen well short of expectations”.
The world is now seeing a revival of interest in development banks. Last year, Nigeria set up the Development Bank of Nigeria with assistance from a consortium of global development banks. The World Bank devoted its Global Financial Development Report (2015) to the theme of importance of long -term finance. The UNCTAD study asserted “the time is ripe to promote development banks. At the national level, the global financial crisis in 2008 has opened space for national policy makers to selectively break with the Washington Consensus policy package and an opportunity to support pro-development finance initiatives”. Which China did so well.
The assets of China Development Bank (CDB) grew from a humble $11billion in 1994 when it was born to about $2 trillion now with its share in the GDP growing from 1.9 per cent to 17.7 per cent. It financed such gigantic projects as the Three Gorges Dam, the Shanghai Pudong International Airport, the Beijing Capital Airport, the Municipal Subway System and much of China’s High Speed Railway Network; it is co-financing the China Pakistan Economic Corridor along with EXIM Bank and ICBC and has projects worth $350 billion in the One Belt One Road (OBOR) regions. It has brought down its NPAs from a perilous 47 per cent in 1997 to 0.8 per cent in 2015. CDB had been a great support to the state-level investment corporations. CDB and China EXIM together lent $684 billion during 2007-14, equal to $700 billion lent by World Bank, Asian Development Bank and Inter-American Development Bank together. It’s the strong belief in development banking that led to China creating the Asian Infrastructure Investment Bank and the New Development Bank with its BRICS partners. The Korea Development Bank hugely helped in transforming Korea into a futuristic economy. Brazil’s BNDES disbursements between 2007-2014 more than doubled. With the projects it supported the bank contributed to a quarter of the nation’s fixed capital formation.
Despite the slush of global savings and near zero interest rates in developed markets, huge gaps persist in the investment needs of developing countries. A McKinsey report noted that the average infrastructure investment rates during 2008-2013 declined in India (minus 0.5 per cent), Russia (minus 0.8 per cent), Brazil (minus 0.3 per cent) and Mexico (minus 0.5 per cent). In its 2030 agenda for development, the UN estimated sustainable development goals funding needs at $6 trillion annually. India needs over $600 billion of investment over the next five years in India for power, roads and urban infrastructure.
Opening up and excessive dependence on foreign capital to fill the investment gaps carry risks. A strong domestic financial system is vital for growth and global leadership. The World Bank’s new broad-based index of financial development placed India in 38th place in regard to financial markets but 102 in respect of financial institutions, which reiterates that India needs to do a lot to strengthen domestic financial institutions. The first step should begin with a detailed blueprint and a master plan for the creation of a strong national development bank that will be in the forefront of funding India’s strategic and long-term development.