Home / Opinion / Online-views /  Why a corporate bond market would have disciplined Vijay Mallya

It is unlikely that finance minister Arun Jaitley was even thinking about Vijay Mallya when he argued in his budget speech that India needs a vibrant corporate bond market. But it is worth asking whether matters would have been allowed to fester for so long if Mallya had been borrowing money from a corporate bond market rather than banks.

Let us rewind to the point when matters began to spin out of control for the defaulting businessman. The decision by Kingfisher Airlines Ltd to buy Air Deccan in order to get access to its international flying rights in 2007 was a risky bet even at that time. What happened subsequently is now well known. Kingfisher Airlines was first hit by record fuel prices. Then revenues came under strain as the Indian economy slowed following the global financial crisis. Losses ballooned.

Other airlines tried to tweak their business models to survive. Mallya refused to do so. He went back to his bankers who now demanded personal guarantees from him. That is how his liquor empire was sucked into the mess. Even a sweet deal offered by the bankers to convert their debt into equity at a stiff premium did not help. The die was cast.

Now, just consider for a moment what would have happened if Mallya had been borrowing from bond investors rather than banks. There is little doubt that the bond markets would have begun demanding stiff premiums from Mallya if he needed money. His cash-flow problems were evident when Indian airports refused to let his planes land unless they were paid upfront. Kingfisher Airlines would have seen its bonds priced as junk rather than being offered sweet deals.

Why the bankers decided to accommodate Mallya despite his growing financial troubles remains to be fully understood. A witch hunt may seem attractive, but the regulators must remember that indiscriminate allegations could lead to collateral damage—risk aversion that will, in effect, bring all major lending decisions to a halt, as it happened at the turn of the century. This does not mean that corruption is not a possible explanation, but it is only one of several.

India has a minuscule corporate bond market given the size of its economy. That is because of a variety of reasons, from the dominance of primary placements to a narrow investor base to a messy regime of stamp duties across states to the absence of protection opportunities from credit default swaps. But perhaps the most important thing to do right now is to push ahead with the new bankruptcy law.

Bond markets are not without their flaws. The financial crisis that hit Wall Street in September 2008 had its roots in a massive misplacing of risk by investors who claimed to be sophisticated. So, India should think of a corporate bond market as one part of its financial ecosystem, rather than a solution to all the problems of a financial system dominated by bank lending. It is not a choice between binaries.

The Kingfisher saga offers us several insights—from malfunctioning boards to bankers who did not take tough action when it was most needed to a promoter whose strategic thinking did not match his personal flamboyance. Even the restructuring of loans that the Reserve Bank of India decided to encourage in 2009 has amounted to nothing more than throwing good money after bad. Neither have other regulatory interventions such as corporate debt restructuring worked as well as they should have.

Businessmen such as Mallya should be held responsible for wilful loan defaults. However, the finance ministry and the financial regulators should also look beyond the personalities involved to examine some deeper structural issues. There are two immediate things the finance minister can do. Push ahead with the bankruptcy law. And work towards building a robust corporate bond market that will demand higher interest rates from companies at the first sign of trouble.

A bit of financial market discipline would have helped in the case of Mallya.

Will a vibrant bond market help avoid cases like Kingfisher Airlines’? Tell us at views@livemint.com

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