Financing India's growth story needs new institutional investment vehicles

Four institutional initiatives could materially accelerate the investment surge needed for the next phase of growth

India’s growth story has moved into a new transformational phase. The production-linked incentive scheme, the National Infrastructure Pipeline, Gati Shakti, asset monetisation, and the Digital India stack have created the foundations for sustained acceleration. The next phase will require a steady surge in investment to fund the three transformations now underway in human development, energy systems, and compute infrastructure.

 

China’s experience offers useful lessons. Between 2007 and 2014, China’s gross domestic product (GDP) rose from $3.5 trillion to $10.5 trillion. Gross capital formation averaged 44 to 45 per cent of GDP and peaked at 46.6 per cent in 2011. Gross national savings ran higher still, peaking at 52 per cent in 2008. The savings surplus over investment made China a net exporter of capital. Foreign direct investment fell from 2.4 to 1.2 per cent of GDP across the period. Portfolio flows were limited because the capital account was tightly controlled. Note that the investment surge that built 40,000 kilometres of high-speed rail, the world’s dominant manufacturing base, and the electric vehicle (EV) and renewables industries was financed almost entirely from domestic sources.

 

The Chinese financing system held deposit rates below inflation. The exchange rate was undervalued. Wage growth ran below productivity. The closed capital account ensured savings could not exit at a market price. The state banking system intermediated those savings to infrastructure and state-owned enterprises at administered rates.

 

This financing system is not available to India. Our capital account allows savings to exit at a market price; if we repress bank deposit rates, it will push savings into gold, real estate, or external assets. Moreover, our middle class savers will not allow persistent negative real returns. A growth model premised on rising household consumption cannot sustain a parallel strategy of compressing household income share.

 

Nonetheless, India needs to lift gross capital formation from 32 per cent towards 38 to 40 per cent of GDP to fund the three transformations in people, energy, and compute necessary now. These incremental investments are unlikely to be financed through household savings or foreign capital. Gross domestic household savings, which averaged 36 to 38 per cent during the late 2000s, have moderated to 30 to 31 per cent over the past five years. Household debt has risen to 41 per cent of GDP, the highest in the historical series. As Indian households gain access to formal credit, more saving capacity is being deployed for housing, vehicles and consumption smoothing.

 

Foreign capital faces its own constraints. The Cambridge Associates infrastructure benchmark places median net dollar internal rate of return (IRR) for US funds at about 10 per cent. A well-performing India focused infrastructure fund might deliver 15 to 18 per cent gross in rupee terms. After adjusting for currency depreciation and fees, this compresses to 8 to 9 per cent net. Thus, foreign capital can contribute meaningfully but cannot close a gap of this scale on its own. How then should our economy build long-duration capital pools at scale quickly? The challenge is to create professionally governed, transparent, and voluntary channels through which long-duration domestic savings can finance long-duration national assets.

 

Four institutional initiatives could materially accelerate the investment surge. First, a national infrastructure investment vehicle scaled significantly beyond current capital, anchored by public capital, asset monetisation proceeds, and voluntary participation from regulated long-duration institutions on commercial terms and under fiduciary safeguards. Such a vehicle should have independence on the lines of Singapore’s Temasek and GIC, professional management with private-sector compensation, parliamentary reporting, and strict co-investment discipline with private capital. The deployment horizon should be 15 to 20 years.

 

Second, the regulators of long-duration savings pools could consider raising permitted allocation ceilings to long-duration equity and infrastructure vehicles to 10 to 15 per cent of incremental flows, against current single digit limits. This would be regulated portfolio construction into professionally managed vehicles, with independent investment committees, transparent benchmarks and risk limits set by the regulators themselves.

 

Third, a blended finance facility partnering with development finance institutions could combine concessional capital with commercial capital, structured with first-loss tranches and currency hedging windows that compress the dollar return gap by 200 to 300 basis points. This would unlock institutional capital from global pension and insurance pools currently unable to clear their internal hurdle rates on emerging market infrastructure. The bulk of the financing would remain domestic; the blended layer would catalyse incremental flows. Fourth, a deep market for long-duration green and infrastructure bonds, with appropriate tax treatment, would channel household savings towards these instruments alongside traditional bank deposits.

 

India’s transformations are achievable. The question is one of pace and ambition. Building long-duration capital vehicles would allow the financing to keep pace with the demographic, climate and technology windows that frame this decade.

 

The author is president of the Everstone Group and visiting professor in practice at the London School of Economics. He is a former Union minister of state for finance and civil aviation, and former member of the Lok Sabha, where he chaired the Standing Committee on Finance