JUNE 14, 2015

By TIOL Edit Team

INDIAN economy is caught in the perennial vortex of corporate debt restructurings (CDRs), interest rate cuts and policy-led bail-outs ever since economic reforms gained momentum in the nineties.

The country is faced with the risk of being perceived as a Ponzzi economy where companies regularly borrow at home and abroad to service existing debt and thus avoid liquidation.

In the case of several business houses, it has become the norm to operate a few tiers of holding companies that borrow secured or unsecured loans to invest both as equity or as debt in the operating companies, which themselves often raise debt to roll-over existing loans.

The balance sheets of highly leveraged companies and lax public sector banks (PSBs) thus require thorough cleaning within a specified timeframe to put the economy back on sustainable growth track.

The World Bank (WB) has done well to draw the Government's attention to this problem in its flagship report ‘Global Economics Prospects' issued on 10th June 2015, the Report says: " Corporate leverage in India is among the highest among major emerging market economies, and foreign currency debt in the form of external commercial borrowings has been steadily increasing over the past decade."

Modi Government has so far not taken a comprehensive view of this biggest flaw of economic reforms. It is, instead, getting sucked into this whirlpool from which there seems to be no exit. It is plugging for quick-fix and patchwork solutions. A case in point is gas pooling scheme for stranded gas-based power plants.

The Finance Minister Arun Jaitley's repeated prodding of the banking system to reduce interest rates on loans is a part of this propensity for quick-fix solutions.

At a meeting convened on 12th June to reviews performance of PSBs and financial institutions, Mr. Jaitley wondered "as to why the banking system, in response to RBI's rate cut of 75 basis points since January 2015, effected a corresponding rate cut of only 25 basis points."

Is it fair for the ministers to prod lending institutions to cut interest rates on loans when they are already making sacrifices by restructuring bad loans running into thousands of crore of rupees?

Reduction in interest rates would no doubt improve the liquidity of the companies, improve their business and cash flows and thus their capacity to avoid loan defaults. The Government is also trying to complement this strategy by asking banks to firm up their plans for additional capital infusion including assets divesture if need be. This approach would obviously help banks to improve their balance sheets.

These solutions cannot, however, prevent PSBs from slipping back into problem of their loans turning into non-performing assets (NPAs) and preventing build-up of NPAs through CDRs and other initiatives unveiled under the aegis of Joint Lenders' Forum.

The solution lies in phased privatization of PSBs or in adopting a zero-tolerance policy for deliberate laxity in providing loans to dubious projects and in compromising the process of due diligence and vigilance. The debt-equity norms should be enforced strictly not only for companies but also for the business houses. All instances of over-lending and multiple-lending with inadequate collaterals should be strictly dealt to serve as deterrent in lending malpractices that are rampant in PSBs.

As put by International Monetary Fund's (IMF's) working paper on 'Corporate Vulnerabilities in India and Banks' Loan Performance' released in dec2014, "the ultimate goal should be to have banks operating on purely commercial principles and able to finance themselves in the capital markets."

Action on the banking front is, however, only one side of the solution. The other part of solution lies in deleveraging stressed and vulnerable companies. Banks are rightly reluctant to lend more to such companies.

The Government thus have to turn heat on such companies to reduce their debt by restructuring their portfolio of assets and projects. They should be asked to monetize their assets to repay loans and thus become creditworthy companies. The sooner the companies clean their balance sheets the better is it for all stakeholders of the economy.

As put by IMF's Selected Issues Paper on India released in March 2015, "One percentage point increase in a company's leverage ratio leads to a 2½ percentage point decline in investment as a share of its capital stock. High leverage is often associated with higher debt service costs, which reduces space for companies to undertake fresh investments. The interest cover metric (ICR, the ratio of the earnings before interest and taxes to interest payments) of the Indian corporate sector's financial health has deteriorated significantly over recent years. Our econometric results confirm that a deterioration of ICR adversely affects investment. In particular, firms with a 1 percentage point better interest cover ratio have about 16 basis points higher investment to capital."

Apart from tackling the problem equally on both corporate and banking front, the Government also has to streamline policies that induce sickness including secondary sickness in the industry by propping up basket cases such as Air India.

The Government also has to improve defence of its policies before the courts, which are generous in ordering stalling projects as response to public interest litigations.