Photo: Reuters
Photo: Reuters

Opinion | The central bank’s circular was designed to tackle India’s NPAs

Reverting to a system where bank managers have the discretion to roll loans over makes it harder to fix our debt problem

The imperfections of language and vocabulary are as lucrative to the legal practitioner as our physical frailties are to the physician," it has been said. The Supreme Court judgement on the Reserve Bank of India (RBI) circular of 12 February 2018, an attempt to clean up the Augean stables of commercial banks, is fundamentally misplaced and will have disastrous consequences for the non-performing assets (NPAs) of banks, especially India’s public sector banks (PSBs), which have the largest proportion of NPAs. The line between “wilful defaulters" like Vijay Mallya and other borrowers who cosy up with bank managers to get their loans rescheduled—and who sometimes get another loan to repay a previous loan—looks at risk of getting blurred. The example of diamantaire Nirav Modi in la affaire Punjab National Bank is still fresh in memory.

Inherent incentives exist for fudging that line. Firstly, PSB managers may go easy on borrowers at the behest of their political masters, who appointed them in the first place. Secondly, the evergreening of loans helps kick the can down the road to a future date, so that NPAs need not be reported under their watch. Thirdly, and more importantly, illicit money incentives also operate, brought into the picture by managerial discretion. This loophole in the Indian bankruptcy process is what RBI wanted to plug. However, at one stroke, all the good work of former governor Urjit Patel and his team to proof it against fudge has now come to naught. The system has been pushed back to being susceptible to prospects of corruption. After all, the banks themselves were reluctant to take the Insolvency and Bankruptcy Code (IBC) route, at least partly because they would then have to recognize losses right there and then.

A Credit Suisse report estimated a total of 14.5 trillion as stressed assets in the fourth quarter of 2016-17. Of this, infrastructure and construction contributed 20%; power utilities 17%; metals (mostly steel) 16%, and telecom 12%. Nearly half the amount had been lent to companies with an interest cover ratio of less than 1—that is, with earnings less than interest due—for eight successive quarters. Much of India’s corporate sector is in a debt trap. The total borrowings by firms with that ratio under 1 (and negative in many cases) is very high.

It is also important to analyse why firms have fallen into debt trap. First, banks are not the best placed to lend to infrastructure firms because this results in an asset-liability mismatch problem. The text book solution is that insurance and pension funds, with long-range liabilities, finance long-gestation infrastructure projects. Besides, commercial banks do not have the project appraisal expertise to evaluate such projects, especially those involving collateral-less finance. The power sector, for example, has many financially unviable renewable power projects, which private equity investors hope to turn viable by forcing their output down the throats of distribution companies through a policy mandate of the state or a subsidy from the centre. We are witnessing the bizarre spectacle right now in this sector. Renewable power is considered a “must-run", while the plant load factor of coal-based generation units is in decline. In telecom, most firms are not doing well because Reliance Jio has changed the nature of the game from competition based on spectrum and voice to a business of cheap data services, in which the new entrant has an advantage on account of its fibre-optic cable network. In all these cases, excessive debt has meant that the risk of losses have been passed on from shareholders of companies to the banks that lent them money, and further on to bank depositors. This would amount to privatizing profits and socializing losses.

The cases of Kingfisher and Jet Airways pale in comparison with the above debt-trapped firms, which include the who’s who of the industry. The fact that Kingfisher’s promoter Mallya was hounded and Jet has been taken over, even while so many other companies unable to repay banks are basking in the sunshine of debt restructuring, shows the extent of managerial indiscretion available to PSBs and even private sector banks.

The latest Supreme Court judgement could exacerbate this sort of behaviour.

I am beginning to see a worrying pattern in rulings of India’s apex court. When the Tata and Adani groups went to the Supreme Court over having power purchase agreements revised on the argument that the Indonesian government decided to determine coal export prices to India based on world prices, and not contract prices albeit Indians had bought the coal mines, resulting in higher costs for Indian power producers—an unanticipated risk which they argued was a force majeure, which it was not—in the first instance, the court correctly rejected their claim and preserved the sanctity of the contracts. But alas, on a revision petition, the apex court buckled and reversed its own judgement in favour of businesses that were bent on passing on their own business risk to consumers of distribution companies. This killed the very idea of a long-term contract.

In interpreting a section of the law in the Novartis intellectual property case, the judge went into details of the parliamentary proceedings to see what the purpose of that law was. That is what should be done, instead of just looking at the letter of the law and giving it paramount importance for jurisdiction. Context is critical in most such cases.

In the case of India’s bankruptcy process, given the overall task of cleaning up the system and ending this malaise of loan rollovers operating like ponzi schemes, RBI was well within its right to send out the circular it did.

V. Ranganathan is a former professor, IIMB.

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