The growing costs of corporate profligacy

Every credit boom ends with two problems—a pile of debt weighing down corporate balance sheets and rising bad loans in the banking system.

India is facing both these problems right now. Much of the problem of excess corporate leverage is concentrated in 10 large business groups that are active in infrastructure, as brokerage Credit Suisse has pointed out in two fine reports. These business groups are: Adani, Essar, GMR, GVK, Jaypee, JSW, Lanco, Reliance Group, Vedanta and Videocon.

The combined gross debt of these 10 groups was Rs63.10 trillion at the end of March. They also account for around 13% of the total loans in the books of Indian banks in fiscal 2012, a concentration risk that deserves regulatory attention. These large borrowers also have massive foreign borrowings, and anecdotal evidence suggests that much of it is unhedged. So the financial health of these 10 borrowers should concern not just their shareholders but also policymakers given the potential risks to financial stability.

The rapid increase in such corporate leverage would have been less of a problem if there was the prospect of healthy cash flow in the near future. That does not seem the case, as a look at the interest coverage as well as debt/operating profit ratios of these 10 groups suggest. Not all the blame lies at their doors, because many of their projects have been stalled in the recent policy logjam. The one sensible mode of meaningful deleveraging in these circumstances is asset sales.

This newspaper reported on Tuesday that asset sales have finally begun. In an interview to Mint published on Wednesday, Reserve Bank of India governor Raghuram Rajan touched on this issue as well. He said that large indebted companies have begun to sell assets, and that “we need more of that”. Rajan also pointed out that Indian firms have shown a preference to sell foreign rather than domestic assets. Take the GMR group, for instance. It has offloaded its power plants in Singapore, as well as sold stakes in a South African mine and an Indian highway project.

Such asset sales will reduce balance sheet pressures. Rajan believes that if such asset sales lead to a meaningful decline in corporate debt, then many companies can use the financial space created to bid for new projects. That remains to be seen. The new Credit Suisse report released in August shows that the gross debt of the 10 large indebted groups continues to rise.

The other leg of the solution is for the government to get stalled projects off the ground. A lot of capital has been invested but projects have not begun to generate revenue. One of the most important examples is of power plants that have not got proper coal linkages or assured gas supplies. The burden of this is being felt by not just companies but lenders as well, as is obvious from the rapid increase in problem loans (both bad and restructured).

The government has been trying to get many large projects moving, but there is no reason to believe that clearing the project logjam will yield immediate revenue to companies, especially since many of the stuck projects have long gestations. But there is no doubt that the first signs of corporate deleveraging are welcome. Indian firms had also gone on a tough financial fitness programme after the end of the splendid boom of the 1990s. They cut flab, and prepared themselves for the next turn in the business cycle five years later.

The current corporate deleveraging is essential. Asset sales are a sensible strategy right now. But Indian companies also need to take home some harsh lessons. As we have pointed out in these columns (The corporate borrowing binge has put India at risk, Mint, 5 September), external commercial borrowings accounted for nearly one-third of the total external debt at the end of fiscal 2013. There was a rush to take advantage of low global interest rates and a stable rupee. A lot of short-term foreign debt has been taken to fund long-gestation projects. Many companies have not hedged their massive dollar liabilities. The costs of such unsound financial management are becoming evident now.

Most large corporate groups continue to have sound financials, but there is clear stress in many ambitious infrastructure groups with strong political connections. Their financial restructuring is necessary, both for their shareholders as well as the Indian financial system as a whole.

Does the financial leveraging by Indian companies now pose a systemic threat? Tell us at views@livemint.com