It is no secret that the corporate debt mountain is one of the key risks facing the Indian economy right now. The bad debts that have piled up in the Indian banking system are the mirror image of the state of corporate finances, with the mess in the state electricity boards adding to the overall stress. Indian corporate vulnerabilities are by far the worst among emerging market peers, if one looks beyond the current regulatory forbearance to take into account both non-performing assets as well as restructured loans in the banking system.

Too much of the current narrative is in terms of the corporate sector as a whole. That sweeping generalization actually hides the concentration of excess debt in a handful of powerful companies. The new version of the explosive House of Debt report, first released in 2012 by investment bank Credit Suisse and now updated, is a useful reminder that a lot of the problem is concentrated in 10 large conglomerates that have gorged on debt. They account for more than a fourth of all corporate loans. These business groups have seen their debt grow seven times over the past eight years. Their interest coverage ratios are low enough to raise questions about their ability to service their debt.

This dangerous growth in corporate debt has several intersecting explanations. Each has its roots in what happened in the country over the past decade.

First, the bursting of the Indian credit bubble, when bank loans grew around 10 percentage points faster than nominal gross domestic product, has left behind inevitable cracks in the financial system. That is what happens across the world once the party ends.

Second, the concerted push for higher private investment in infrastructure encouraged these companies to take on excess debt, while the inexplicable policy of allowing companies in the non-tradable sector to take on foreign debt is beyond rational economic explanation.

Third, the regulatory mess during the last few years of the second Manmohan Singh government ensured that projects got stalled after money was put on the ground. It is not unusual to meet bankers or business leaders who say their projects got into trouble because of policy confusions that were beyond their control.

Fourth, a look at the list of the most heavily indebted companies shows that there is a strong link between the current financial fragility and the crony capitalism excesses of the past decade. Almost every conglomerate in the Credit Suisse report is active in oligopolistic industries that have strong links with the government.

What now? The sanguine hope that matters will gradually revert back to normal as the excesses are worked out of the system is not of much help to policymakers. There are two reasons why more urgent action is needed. First, financial fragility in the Indian private sector is one clear worry among global investors. Second, the Indian economic recovery cannot be sustained unless private-sector investment picks up, and that is difficult unless corporate financials improve.

One policy option that is bandied about is the creation of a bad bank that will buy out stressed corporate debt, something like an Indian version of TARP. There is the issue of budgetary cost. And such a strategy will be nothing more than the use of taxpayer money to bail out powerful business groups. It would be far better if companies are made to work with their bankers to reduce leverage through asset sales and equity issues.

Promoters will have to bear some of the costs of financial restructuring—either by bringing in personal funds to help deleverage the companies they control or actually losing control of the companies. Dumping all the costs on the taxpayer is unfair—and is bound to be political dynamite.

The upshot: India is now coming to terms with the costs of crony capitalism. The bill should not be presented to taxpayers.

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