Even while the debate on banning wilful defaulters from bidding for their stricken assets rages on, it is important to appreciate that while bankrupting their businesses wasn’t always the motive of all those on the Reserve Bank of India's infamous list of defaulters, the poor decisions they made were responsible for their current state.
That a majority of these stressed assets were germinated in a short span around the time of the global financial crisis also shows that there was benign political indifference to the conduct of public sector banks even if we accept the charitable argument that there was no active collusion. As an aside, why should they have been doing project financing in the first place? Isn’t that best left to bond markets and investment banks?
As a 2015 EY report titled Unmasking India’s NPA issues, pointed out, there are three root causes for the grief caused to the banks: diversion of funds to unrelated business/fraud, lapses in the initial borrower due diligence, and change in political/ regulatory environment leading to business loss, in that order of significance.
While the first two have received adequate spleen, not much attention has been paid to the factors that caused a lot of the projects to turn sour. To repay the loans or at least pay the interest on them, companies needed to complete the projects they had undertaken. That they didn’t, or couldn’t, lies at the heart of the default crisis and also holds out important lessons as we rail against the current lack of private investment.
A large chunk of the default has come in sectors such as infrastructure (including airports, roads and ports), power, telecom, metals (especially steel), textiles as well as cement. Most of these sectors were subject to the twin menaces of a steep fall in global demand as well as regulatory flip-flops at home.
Take, for instance, Essar Steel Ltd which accounted for a third of the group’s total debt. Steel has been a global casualty, a result of China’s unbridled capacity build-up and reckless dumping on the world markets. Between 2008 and 2012, steel prices had dropped from $1,265 per tonne to $300 per tonne. In the absence of a collective response from governments in affected countries to what was clearly a blatant disregard of global trade norms, the suffering was secular.
Plus, there was the policy flip-flop which meant that there was serious disruption to the supply of iron ore and coal needed to make steel. A June 2015 Financial Stability Report published by the Reserve Bank of India noted: “Five out of the top 10 private steel producing companies are under severe stress on account of delayed implementation of their projects due to land acquisition and environmental clearances, among other factors."
The Videocon group borrowed over Rs20,000 crore for oil and gas discoveries in Brazil, Indonesia and a host of other countries. The slump in oil prices after 2015 rendered the debt-driven investment unviable. The Jaypee group built a state-of-the-art Formula One track at the Buddh International Circuit. A change in government policy on entertainment tax led to F1 withdrawing in 2012, leaving the already under-pressure group holding a dud.
In a Catch-22 situation, stricken companies were forced to sell their performing assets while also cutting back on capital expenditure, which in turn worsened their capacity to service debt and meant that overall debt continued to rise even after a fire sale of assets.
Defaults are a part and parcel of global business. Culprits include countries as diverse as Argentina, Mexico, Russia, Iceland, Greece and long before any of them, the US in the early 1840s when 19 of its 26 states defaulted following a build-up of debt for infrastructure projects. In Asia, individual businesses collapsed spectacularly in 1997 following the currency crisis with a number of South Korean chaebols defaulting on their loans.
Nor is the situation any different today. According to S&P Global’s 2016 Annual Global Corporate Default Study, in 2016, the number of defaults globally expanded to 162 from 113 in 2015 with the US continuing to account for the majority of defaults globally in 2016. The prolonged period of low oil and other commodity prices was the biggest factor behind the overall increase in defaults for the year.
But if external factors alone had been responsible for the defaults in India, they should have impacted all the companies in each sector equally. That they didn’t and today a Tata Steel Ltd has emerged stronger despite going through the steel wringer while Electrosteel Steels Ltd has gone under, also reveals that operational efficiencies and management capabilities play an equally important role. Most promoters seemed to have forgotten that investing at the top of a commodity cycle is fraught with danger. Much of the pain and the destruction of public money stems from this basic error. Those arguing for allowing defaulting promoters back into the companies they mismanaged in the first place, may do well to remember that.
Sundeep Khanna is a consulting editor at Mint and oversees the newsroom’s corporate coverage. The Corporate Outsider will look at current issues and trends in the corporate sector every week.
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