Generally, we Indians do not take responsibility for our failures. We prefer to blame someone else for our woes—and the business community is no exception to this unfortunate rule.
I could be wrong, but I do not remember seeing a single article on the US subprime crisis that points fingers at the US Fed. It is assumed that the American banks that eagerly lent to customers with dodgy credit histories are to blame for the pile-up of bad loans. The subprime edifice started cracking after the Fed pushed up interest rates—loans became more expensive while the prices of houses that were offered as collateral dropped as a result. More than one out of every 10 subprime borrowers have been buried under the debris.
But, eventually, the blame lies with the lenders who dished out loans and families that borrowed—and not the Fed. They assumed that interest rates would not go up and real-estate prices would not go down. They did not assess risks well enough, and are paying the price for their cavalier attitude.
There is a lesson here for Indian companies, that still do not own up to the fact that they mismanaged their finances during the last economic boom of the mid-1990s. They prefer to blame the Reserve Bank of India (RBI) instead—and will be happy to blame RBI during the next spot of trouble as well.
RBI may or may not be right in increasing interest rates. There have been prolonged skirmishes among economists on this issue. But companies (and consumers) should always be aware that interest rates move up and down. There is no point in screaming murder when they move against your expectations. Interest rate risk cannot be wished away. It has to be managed.
In recent years, many Indian companies have journeyed back from the gates of financial hell. RBI hiked interest rates in 1996 and 1997, thus setting off hidden bombs that left balance sheets in tatters. The central bank may have lit the match, but who put the bombs there in the first place?
Back then, many companies were enticed by three years of strong economic growth after 1993 to go on an expansion spree. They borrowed heavily and sometimes tried to fund long-term capital expenditure with short-term borrowings. They completely misjudged the commodity and interest rate cycles.
In 1999, two years into the ensuing recession, over 45% of the companies rated by Crisil were downgraded. The downgrade ratio today is as low as 1.74%. Over the last 27 months, not a single company has defaulted on a financial instrument rated by Crisil, the longest such period since 1995.
The scion of one of the country’s biggest business families told me about a year ago that there were two things he had learnt after the recession of the late 1990s, when his company almost went bankrupt. One, a project should be profitable even at the bottom of a commodity cycle. Two, never start work on a new venture without tying up the finance. He would never rush headlong into a project again.
As interest rates rise, it is time to ask whether such lessons are being forgotten all over again?
Though the corporate sector as a whole is in the pink of financial health—as the first corporate results for 2006-07 show—don’t miss some early signs of deterioration. Look at the surge in foreign borrowings, large capacity expansions that will eat into free cash flows and the global leveraged buyouts. Indian companies have proved their mettle in recent years, but this does not necessarily insure them against irrational exuberance in the future.
“The significant improvement in Indian companies’ financial position over the last few years has been accompanied by a new-found confidence among corporate managers, resulting in a palpable increase in their risk appetite. With a large number of companies either announcing, or already in the process of implementing, large capacity expansions or aggressive acquisitions, the key to maintaining the current levels of credit quality depends on how well the growth is managed, and in what way it is funded,” says Crisil in a new research note published on 11 April.
John Maynard Keynes wrote many decades ago on the “animal spirits” of entrepreneurs, describing this as: “… a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.” In other words, entrepreneurs depend on gut feel rather than a statistical assessment of risks.
What Keynes wrote elsewhere about naïve optimism is also worth remembering: “… the thought of ultimate loss … is put aside as a healthy man puts aside the expectation of death.”
You may not agree with Keynes’ broad generalizations, but these are words that are undoubtedly worth heeding.
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