Policy entropy is usually a slow process. The sheer scale of the bad loans problem has ensured that attempts to chip away at the landmark Insolvency and Bankruptcy Code (IBC) have begun just 15 months after it was written into law. The Reserve Bank of India (RBI) is under pressure to dilute its 12 February circular that abolished the previous alphabet soup of regulatory forbearance. The Indian central bank has asked lenders to consider even those with one day of missed interest payments as defaulters, and take all companies in default for over 180 days to bankruptcy court. It is interesting that the euphoric reaction to the resolution of steel loans with minimal haircuts has quickly been replaced by criticism, as the IBC process has moved to more tricky areas.
The core of the problem: the massive bad loans in the power sector. Independent power producers have dragged RBI to court, even as there is pressure from the government to treat power sector defaults as a special case. The central bank should not buckle under. The argument is that many power producers are in trouble because of factors beyond their control such as bankrupt state electricity boards, the cancellation of coal licences and broken transmission grids. As Ashwini Mehra, a former deputy managing director of the State Bank of India, has noted in this newspaper last week, power sector loans are the unstated focus of the new Project Sashakt launched by the finance ministry. Bankers are also worried about the steep haircuts that they face in power loans, especially if the defaulting companies are liquidated rather than sold, unlike the steel loans where was aggressive bidding.
Regulatory forbearance for power sector defaulters is riddled with problems. The legalistic argument is that making a special case for power producers will be against the spirit of Article 14 of the Indian Constitution, which guarantees equal treatment for everybody under law. There is no reason to create a special dispensation for any one sector. The more practical worry is that regulatory forbearance is a slippery slope. Companies with political heft in other sectors will begin to ask for similar special treatment. For example, textile companies could argue that millions of jobs are at stake or infrastructure companies that too many national projects will get stuck in a rut. Any attempt to bypass the IBC will open the floodgates for special interest lobbying.
The government need not be a passive spectator if it is so worried about the woes of the power producers. It has the ability use instruments in its fiscal or quasi-fiscal armoury to help them, but only within the IBC system rather than outside it. It should be possible to float a special purpose vehicle (SPV) to buy power assets that are in default in bankruptcy court. Or it can ask cash-rich power companies in the public sector to step in. A government that uses the Life Insurance Corp. to buy IDBI Bank is surely open to financial engineering of this sort. These are not optimal solutions, but can be considered in case the government is deeply concerned. All that this newspaper argues is that the purchase of power assets in default by such an SPV should be done within the IBC system.
The weak credit culture that is now hardwired into Indian political economy has led to cycles of defaults that have hurt tax payers rather than large industrial groups. The origins of the current banking stress lies in the credit bubble inflated during the boom years before the global financial crisis, and the short burst of recovery after it. Banks were goaded to lend to politically favoured groups. The IBC seeks to break this bad equilibrium by shifting power from borrowers to creditors. It bolsters the sanctity of the debt contract. The Narendra Modi government deserves credit for pushing through the IBC. It should defend what it has achieved rather than fall prey to myopic tinkering.
All deep reforms make their impact over a time period that is longer than the immediate economic or political cycle. The IBC is one such reform, as are the goods and services tax (GST) and the flexible inflation targeting regime. These have to be defended, and nurtured. The current pressure on the RBI to ease bankruptcy norms for select sectors is thus unfortunate.
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