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Institutional Integration

Now that the development financial institutions of the Central Planning era have outlived their purpose, the organizations are being re-deployed. IFCI is the latest.

By Roshni Jayakar

In February 2004, something momentous happened. India's development financial institutions (DFIs) ceased to exist. At least in their traditional form. The Board of the oldest DFI, the Industrial Finance Corporation of India (IFCI), approved the Union Finance Ministry's proposal to merge the organization with Punjab National Bank (PNB).

The move, when announced as part of the Union Budget speech by the Finance Minister Jaswant Singh, was greeted with a mix of relieved approval and smouldering dismay.

Approval because it is widely believed that the DFIs are best shorn of their earlier responsibility---or providing 'development' funds that all to often ended up developing little other than politicians' patronage networks.

Dismay because it is also believed that India, being a woefully underdeveloped country, still needs gestation-covered funding (with payback expected only after a certain period) for projects that the market may not be too excited by.

Well, as things stand, it is the approval side that's winning the argument. This is evident in terms of parliamentary strength as well. As recently as in December 2003, the Indian Parliament passed a bill repealing the IDBI Act of 1964, paving the way for another DFI's complete conversion into a bank (IDBI Bank had been functioning for a while).

"DFIs as an important instrument of state policy are being phased out," says Ashwani Puri, head of financial sector advisory, Pricewaterhouse Coopers. That the DFIs would eventually have to become creatures of the free market was obvious several years ago. The reformist government of the mid-1990s signaled so by withdrawing its old guarantees and concessional funds. Tax-payer's money, it was made clear, would not be used for such purposes for much longer. Industrial development was now a private sector imperative, and the government would restrict itself to setting the rules of fair market play.

The first DFI to go the market way was ICICI, which had originally been set up with private sector and World Bank participation in 1955. In that sense, it wasn't quite a government entity, and when in the 1990s it launched ICICI Bank, it was seen largely as a logical brand extention. Little did people realize that eventually the younger, better-run ICICI Bank would be 'reverse merged' with the parent institution to create a single large bank. That's what happened in 2002.

The case of IDBI is slightly different. It was started in 1964 in the premises of the central bank, RBI, to take on the role of an apex institution financier. In the 1990s came IDBI Bank, which started off well, but the old institution was still in a bad way. Interest rates and tumbled and the spreads had got squeezed. IDBI was ill-equipped to face market changes, and lobbied for concession after concession-till the ICICI solution was proposed for it, too.

And IFCI? This was an even more special case, in some ways. Largely because it did virtually nothing to adapt itself to new realities, hoping all along (as it appears) to get merged into a better-functioning entity. Well, it wasn't a bad strategy, as it turns out.

Just that the turning over of the institutions to the market is not quite as plain as it seems. Remember the 'dismay' mention some lines above? It has had to be assuaged. So the Finance Ministry intends the institutions to continue their do-gooder duties.

"To make funds available for emerging new projects," says Puri, "the FM is looking at these institutions to provide funding within the framework of the market economy."

The model might be similar to what Japan did with its Ministry of International Trade and Industry (MITI). Established in 1949, it continues to play a role in the development of the Japanese economy and industry. Its budget remains as huge as ever, and nobody has accused Japan of being a closed economy.

According to Ritesh Maheshwari, head of financial ratings, CRISIL, sectors such as small scale, infrastructure, power and trade continue to need DFIs. "And the transition into a bank will help them reduce resource cost and do viable business," he adds, cheerfully.

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