Barely a month ago, Deepak Parekh, chairman of Housing Development Finance Corporation (HDFC) was all praise for the speed with which Ajay Tyagi, chairman of the Securities and Exchange Board of India (SEBI), had accepted his suggestion to get listed companies to mandatorily report to stock exchanges every default in payment to banks or financial institutions. Mr Parekh had told us that this move would give investors timely information, since there is a huge lag today before they get to know about financial difficulties of listed companies. On 4th August, SEBI issued a circular making it mandatory for companies to report any lapse on payment of interest or principal to their lenders.
This was to become applicable from 1st October. The reporting requirement would cover default in payment of interest on loans from banks and financial institutions, interest/instalment obligations on debt securities (including commercial paper), external commercial borrowings (ECBs), medium term notes (MTNs) and foreign currency convertible bonds (FCCBs). SEBI said the move would fill a ‘critical gap’ in the information available to investors.
Then, on Friday, 29th September, a press release sent after 11pm from an iPhone scuttled the move with one line: “It has been decided to defer implementation of SEBI circular no. CIR/CFD/CMD/93/2017 dated August 4, 2017 until further notice.” The SEBI chairman was in New Delhi for the weekend and, perhaps, the action was dictated by instructions received there. It is not clear whether the objections of the Reserve Bank of India (RBI) have forced SEBI to withdraw its circular; but the market regulator’s silence reflects a panic about the state of bank finances and the government’s struggle to deal with bad loans. The SEBI circular was aimed at protecting retail investors and mutual funds (which pool retail investment) by providing immediate information about payment difficulties of
Remember, while SEBI was all set to force corporates to disclose information about defaults, RBI has refused to name defaulters, despite a Supreme Court order. Consider how the SEBI circular would have affected banks. Bankers do not report defaults for at least three months and they are used to ever-greening accounts and delaying—as long as possible—the classification of loan defaults as non-performing assets (NPAs). By forcing companies to report payment defaults immediately, banks would no longer have the power to make a variety of adjustments, including offering fresh loans (or other forms of finance, including loans to group entities) to hide the NPAs in their own books.
Public sector banks (PSBs) were already reeling under the pressure of bad loans when the national democratic alliance (NDA) came to power. The Congress—led United Progressive Alliance (UPA) had ignored the bad loans issue and routinely papered over a possible panic by doling out thousands of crores of rupees to recapitalise PSBs. NDA was expected to force them to clean up their books and stop their corrupt lending practices. But prime minister (PM) Narendra Modi began his innings by launching the Pradhan Mantri Jan-Dhan Yojana in August 2014. His stiff targets forced banks to divert almost all their energy into opening these accounts. Since many nationalised banks were also kept headless for a long time, there was nobody to ensure that core functions did not take a hit. Barely had the pressure about Jan-Dhan ended, when the PM announced demonetisation of Rs500 and Rs1,000 notes on 8 November 2016, once again plunging banks and the entire country into chaos for the next few months.
Bad loans have now reached a crisis point, with stressed assets of the entire banking industry estimated at nearly 10% of all outstanding loans. The government passed the Insolvency and Bankruptcy Code (IBC) to help banks with faster loan recovery from wilful defaulters. But, as with all grandiose schemes disconnected with ground reality, there were two major problems. The first case of successful resolution under IBC, involving Synergies Dooray Automotive Ltd, has led to a complaint by Edelweiss Asset Reconstruction before the National Company Law Appellate Tribunal (NCLAT) calling it a fraud and a sham. Lenders took a 95% haircut in this case and there are grounds to suspect that an associate company of the promoter group has contrived to wangle control.
The decision has had a huge hidden impact. Only in July this year, industrialists believed that the PM’s office was directly monitoring the 12 cases marked for insolvency action, where the outstanding debt is over Rs5,000 crore and 60% of it is classified as non-performing. A steel industry magnate told me that bankers were asked to ensure that at least six of these companies had a change in management. After Essar Steel’s audacious, but failed, legal challenge to the recovery process, the Synergy Dooray case and lower GDP numbers, the mood has changed completely. Three months later, the same source says that every defaulter company will sail through the National Company Law Tribunal proceedings with lenders taking a haircut and promoters retaining control either directly or indirectly. Prashant Ruia of Essar Steel has already gone public about his confidence that the family will remain firmly in the saddle.
This has cast a shadow over the entire IBC process and raises concern about yet another mechanism to recover bad loans that may be doomed to fail. Was the IBC legislation pushed through in a hurry without taking the time to eliminate possible loopholes? There seems some merit to this disconcerting view, but it fits in perfectly with this government’s quick-fix approach. A bankruptcy legislation has a significant weightage in the World Bank’s Ease of Doing Business, which is due for a revision in October. Government mandarins rushed through the IBC legislation hoping for a 20-point jump in India’s rank, from 130 last year.
India’s GDP growth, which was 9.2% in the third quarter of 2016, has steadily dropped to 5.7% in the April-June quarter of 2017. While companies were struggling to cope, the government went ahead with a complicated Goods and Services Tax (GST) with multiple tax slabs, onerous reporting requirements, frequent changes in rates and an online filing system that was not robust enough. While a simple GST would be beneficial in the long run, especially if we are able to move towards a single rate, at the moment, GST has caused a huge disruption, especially among exporters and traders.
In this scenario, the instant reporting of defaults would force banks and rating agencies to take immediate action such as classifying loans as a default (with commensurate provisioning for bad loans) and downgrading of credit rating. All this would have had a big impact on loss-making nationalised banks, which are seeking a fat government bailout (or recapitalisation) at public expense. With the bull run of the Indian capital market having paused, in response to bleak economic numbers, a spate of rating downgrades would have only precipitated a further decline in share prices. A desperate government appears to have pressured SEBI to drop the investor-friendly move and allow the obfuscation by lenders and borrowers to continue.
While institutional investors with large research teams have ways to ferret out information about corporate health, this move leaves retail investors at the mercy of sketchy disclosures made to stock exchanges. That SEBI was forced to defer an investor-friendly action to allow banks and companies to hide corporate defaults reflects adversely on this government which was voted in with such hope and expectation. What is worse, every problem faced by the economy today is self-inflicted. With low oil prices and a good monsoon after two years of drought, and enormous goodwill and support from the public, the government ought to have pushed for high economic growth, job creation and kick-starting investment supported by a clean and efficient administration. Instead, with less than two years for the next general elections and negative outbursts from its own party stalwarts, the government is in defensive mode and angrily attacking those who raise valid questions.