Lessons from India’s debt crisis

Live Mint 16 Sep 14
Cronyism and regulatory forbearance are reasons behind the debt problem

Over the past year, this newspaper has highlighted the worsening debt profile of Indian companies. Recent data show that there has been only a slight improvement this year, and India’s bad debt burden continues to be the economy’s Achilles heel, preventing a rapid recovery. But rather than pushing for quick fixes, policymakers need to acknowledge and correct the mistakes of the past which has led to the debt pile-up.

At first glance, India’s debt problem appears to have become less acute. But as a recent Mark to Market column by Mobis Philipose pointed out, the concentration of debt in stressed sectors such as steel, power, and infrastructure remain worryingly high. A year ago, nearly one in three companies had a net debt exceeding their market capitalization. Less than one in five belong to that category today but they account for a whopping 57% of the total debt of all firms for which data was available. Corporate debt levels in India are among the higher side in Asia, and bank balance sheets among the most strained.

India’s external debt figures are also worrying. According to the annual report of the Reserve Bank of India (RBI), India’s external debt-to-GDP (gross domestic product) ratio rose 1.3 percentage points to 23.3% in the year ending March 2014 over the previous year. Short-term debt (by residual maturity) as a proportion of overall debt was 40%, as of March. It is likely that the level of external debt has gone up in the current fiscal year owing to an overseas borrowing binge by companies. Many of these firms, particularly in the power and utilities sector may not have hedged their positions adequately, posing systemic risks, a recent report by the Bank of International Settlements warned.

Both India’s domestic and external debt vulnerabilities are concentrated in a handful of large conglomerates in the power, materials, and infra sectors which expanded at breakneck speed during the boom years. It does not appear to be a coincidence that many of these firms are politically connected, and that the bulk of the bad debt burden has been shouldered by state-owned banks, which have been vulnerable to manipulation by New Delhi. But cronyism is only one reason for the bad debt problem. Regulatory forbearance in the immediate aftermath of the great financial crash in 2008 is also to blame, since such forbearance merely postponed the day of reckoning for indebted firms and hid the true leverage levels.

Even now, it is very difficult to take the reported debt numbers at face value given that banks still have a lot of leeway to postpone recognition of bad debt. An examination of United Bank of India’s balance sheet by analysts at Barclays Capital showed that there were no signs of stress before the sudden spike in bad assets of the bank earlier this year.

There are three key takeaways from India’s debt crisis. First, the governance and management of banks in India need urgent overhaul. Banks must follow more transparent accounting standards, and RBI must take a closer look at their lending mechanisms. State-owned banks need special attention, and they must be insulated from political pressures. The Nayak committee recommendations on reforming state-owned banks should be taken up without further ado.

Second, rules for promoters have been far too soft for far too long, and that needs to change. RBI has already tightened norms for wilful defaulters, and according to a recent Business Standard report, the capital markets watchdog, Securities and Exchanges Board of India might join force to make it difficult for such defaulters to access the capital markets. Such steps are welcome but we need more.

Third, we must resist the temptation for any kind of bailouts, whether it is through special packages for stressed sectors or through state owned asset reconstruction companies. It does not take long for private debt problems to turn into public debt problems, and we must avoid that trap. The deterioration in asset quality of state owned banks means that the heavy burden of refinancing them has already fallen on the taxpayer’s shoulders. It will be unfair to burden the taxpayer further.

Can regulators rein in the risk of high leverage? Tell us at views@livemint.com