Pandemic Impact: Survivor....By Uday Kotak

Edited excerpts.

You’ve said it’s impossible to estimate GDP growth at a time like. I’m not asking you for a number, but can you share your assessment of the path to recovery? Best case, worst case and the most-likely case?

Uday Kotak: I have two points to make in this answer. Point number 1 is beware of statistics, statistics and damn statistics. You cannot predict statistics properly in these turbulent times, and therefore watch out for that carefully. And if at all you are looking at those statistics, look at data month-on-month. Use things like Fastag data, GST data, electricity consumption data as the basis of predicting the trend line, and be very careful about averages. April 2020 versus March 2021 are different points as I see it. Rather than taking the average for the year, which will give the wrong sense of how India is growing, I'd plot it on a month-on-month basis with more real life data, rather than just what may appear as statistics which aren't validated by solid science and valid data. Be very careful of that.

Point number 2 is that I think about the GDP of India in the context of how most of you think of capital markets, companies and their earnings.

Let me say what I mean: most investors and analysts are looking at 2020-21 as a washout year for earnings. So what are analysts doing? They are looking earnings estimates for FY22 and FY23, and they are valuing companies on that basis. The markets are taking a medium-term view on overall equities and individual stocks. I'd really like the stock called "India" to also be looked at in the medium term. There's short-term pain coming out of a health crisis of an unprecedented nature. The way forward is unclear in the short run. But if we look at a one-year forward view, it'd be reasonable to assume that we'd have better answers, cures and/or vaccines. Taking a view on what a health pandemic will do to short-term growth will be very dangerous, compared to taking a longer term view on the stock called India. And in that context, my advice is , let us take in the short-term measures that are primarily to protect life and livelihood. The longer-term issue is taking significant measures that'll structurally change the nature of India's growth.

What do we need - to make medium-term trend growth better? That's where the focus of all of us in India should be.

The underlying reason for the Moody's downgrade is that they didn't think that the measures taken so far have created an environment which would help India grow out of its debt-to-GDP problem. So I come back to growth - you said recently “growth is imperative”. Where is that growth going to come from? Banks have been risk averse, NBFCs have been tamping down on growth. And the government's relief measures have been very tepid, in fact, you'd have to agree that they've been the most risk averse in the current situation.

Uday Kotak: Banks are ready to lend to people who are risk averse to borrow. There are many companies we'd love to lend to. But they have significantly lower working capital cycles due to the lockdown, they don't need the money, and they are saying thank you very much.

Or some are deleveraging (Reliance Industries)?

Uday Kotak: So therefore the answer to risk aversion is to get private investment going. It's about the fact that we need animal spirits back in Indian business and entrepreneurship, for people who have the capacity to take the risks.

And thereafter we could see private investments come back for entrepreneurs. Entrepreneurs have gone into a shell for a long time. We need to wake them up and make them less risk averse.

For two years, we have seen very little private investments. Now, after this unprecedented crisis, where is that private investment going to come from? Where's the demand to spur that private investment?

Uday Kotak: My view is - think about it like what the markets have told you in the last few months. I believe that the next 12-18 months will be a great time to look at things from a different lens. Provided, that in the next 12 months we get some clarity on the health front. We need to assume the health issue will find some solutions in the next 12 months.

On the issue of the last few years, Menaka, there has been a significant cleansing in India. Some of the ways that businesses were run in India, even in larger groups, left a lot to be desired. The cleansing process is behind us.

A lot of entrepreneurs who may be willing to invest at this stage may not have the capital to make those investment calls.

You cannot have institutional partners with poor governance track records. You need to have commitment to governance and entrepreneurship, and sharing of risks. That's the way forward.

So, you are suggesting a structural shift away from debt and more towards equity financing?

Uday Kotak: If you look at the pandemic and the impact to the economic cycle of corporate India, three points are the pressure points for most companies.

First, the sector they are in. The more front-facing the impact of Covid on that sector, the more they are affected. So, for example, airlines or hotels.

Second, all businesses with high fixed operating costs, where break-even points are very high. Those companies have been disproportionately affected because the revenue side has collapsed and the operating costs are not easy to bring down.

Third, is high financial leverage ratios. In simple language, debt-equity ratio. Companies with high debt-equity ratios will be under greater pressure at this time than companies with lower debt-equity ratios. In the past, many companies had high debt-equity ratios because they had very good debt-EBITDA ratios. Because EBITDA was growing very fast therefore they could afford to take more debt and have higher debt-equity. But EBITDA runs the risk of getting collapsed this time around because of the pandemic. Therefore, absolute financial ratio on the leverage side is crucial. Therefore, I recommend debt to be more constrained for businesses for two reasons, one, navigate the storm better and two, there is opportunity on the other side of the shore. And the greater is your buffer as a balance sheet, more you can take it.

It looked a bit apocalyptic, why is Uday Kotak raising a billion dollars at these prices, why is Mukesh Ambani in such a hurry to deleverage? But you're saying that your approach and his approach is broadly driven by one common view - move to cash, reduce leverage because who knows what the EBITDA will look like for the next year or two.

Uday Kotak: And for the opportunity on the other side.

You spoke of partnering with institutional investors, even they will look for growth, so I come back to my growth question. The broad assessment is that the government has not done enough. They say they will do more. Where do you see more space for more action? Both on the monetary side as well as on the fiscal side.

Uday Kotak: I think the RBI has done a lot, and we underestimate what they have done. They have not only dropped the repo rates, they’ve flooded the market with liquidity and we are operating more at the reverse repo rate or lower. The RBI has made a dramatic shift in the monetary policy and frankly followed the mantra: we will do whatever it takes.

On the government side, I think we have to be fair to the situation. Pre-Covid, the centre-state combined deficit was anticipated to be 6.5% of GDP. As we talk today, that number looks more like 11 to 12% of GDP. So, give or take say 5 percentage points of GDP is the additional loss that the sovereign has taken between centre and state because of Covid. It may be because of lower revenues, it may be because of the package, but all in all 5 percentage points of GDP is Rs 10 lakh crore on a Rs 200 lakh crore GDP. So, the government of India has already taken a hit of Rs 10 lakh crore, coming into Covid. It will need to do more as we go forward, probably for lives and livelihood in the short run.

But it has also on the MSME front played a very smart move with a Rs 3 lakh crore government guarantee which does not hit the deficit for this year. It is a guarantee over 4 years. Not all 3 lakh crore will be invoked, therefore, the loss will be lower. And it would be ammortised effectively over a 4 year period. Therefore no impact on the deficit - but it has created a Rs 3 lakh crore liquidity for MSMEs. I think the government needs to think about more such interesting and creative ways to create support for the economy, without giving up discipline to an extent where our financial stabilities are at risk.

Let's talk a little bit about the efficacy of what's been done. One question that keeps coming up is, in a risk averse environment when the most of what you are trying to push through is through the financial system, is there enough transmission efficacy? I’ll give you an example- there are media reports of small business owners saying banks are giving loans under the MSME scheme but asking for the money to be used to pay outstanding loans. Will this risk aversion in the system allow growth to come back?

Uday Kotak: My assessment of the MSME guarantee scheme is that it is very categorical - it is for new money to the borrower and the borrower doesn't need to change the structure of his existing loan and the repayment structure under that. And I think that is something that should be discouraged, and in fact the borrower must take the money based on his need and has the freedom to return or not to return based on his cash flows, not on the basis of what the bank asks him to do.

So are you concerned at all about the transmission efficacy of many of these measures - LTRO, TLTRO, Guarantee Schemes?

Uday Kotak: It will work Menaka. I think it will be net liquidity in the hands of the borrower.

You expect it to work effectively?

Uday Kotak: In my view, it will work effectively and the borrower must start his business, that is important. The borrower should not be risk averse. He should not take the money under the MSME guarantee scheme and say I will not start my business and I will repay my loan. That is not what is expected from the borrower as well.

That's fine, but banks should not be saying that either.

Uday Kotak: The bank should not be insisting that take that money and repay, I think that is wrong.

That was a concern Raghuram Rajan raised in his interview with The Wire, that there's a moral hazard here.

Uday Kotak: I think that we have to see how it plays out. The fact of the matter is that the borrower must make the choice of what he wants to do with the money.

I understand that you like the principle behind these guaranteed loan schemes, but are some of these structures way too complex to execute in a timely fashion? We always get stuck in the bureaucracy of these things. Like the September 2019 real estate rescue fund that’s yet to take off.

Uday Kotak: First, I agree with you. I think the trouble is the devil is the detail and we must avoid complexity. If there is one principle that I have learnt in my entire business career, it is to keep things simple. And my advice to the government is keep things simple in terms of your packages. From that point of view, the MSME guaranteed loan package, after some wrinkles initially, is now in place and that's less than 30 days.

Is there fiscal space to consider a Universal Basic Income of sorts - more direct transfers in the hands of lower income people, in order to boost demand. There are lots of different solutions out there recommended by different economists. If the government were to do more on the fiscal side, would you recommend measures like these?

Uday Kotak: My view is there is no space, but do we need to go in that direction, my answer is yes.

So there is NO space, but...

Uday Kotak: I think we may have some space to move in that direction but we don't have space for a holistic UBI today. I would want us to move in that direction, starting with the bottom of the pyramid, and then gradually move up as we go forward. We must move in that direction, because I think that the future of jobs is a big issue, there are many, many variables out there including physical vs digital world which is changing the nature of jobs. And rural/urban re-balancing which is happening in front of us. The need for healthcare, education, different kind of jobs, different skills and there will be interim shocks for people from the job point of view and we need to revisit jobs. At the same time we need flexible labour policy for business and industry to be competitive.

It's a journey, we have to get going. There is certainly no fiscal space for a full-fledged UBI today, but this is the time. And I think the pandemic is going to change the perspective of most people in India because we have an obligation that every Indian must have a fair chance of life and livelihood.

You’ve said the government should do more. Is there a level, a percentage of debt, you are comfortable with beyond which we might be getting into financial instability territory? Also, what is your view on the borrowing more versus monetisation of deficit debate?

Uday Kotak: Before the Covid-19 pandemic the government debt to GDP was give or take around 70%. I think we will get to 85%. We start getting into amber and red category beyond that.

Let me come to asset quality now. We have a six month loan moratorium running right now. India is, according to Goldman Sachs, the country with the highest percentage of loans under moratorium. By when do you think we will have a good idea of how many loans are alive and kicking and how many would have turned bad? September, October, November...do you have a timeline you are watching?

Uday Kotak: I want to make another point first, that is on interest during the moratorium period. I am firmly of the view that the primary responsibility of a bank is protection of depositors' money. And just as we cannot even dream of a situation where depositors’ interest and principal is not repaid. Banks are convertors. It is unthinkable that the borrower has no obligation to pay interest and the depositors' interest must be paid. We need to get this right and I do hope that the government supports the RBI's position strongly and ensures that we get a fundamentally stable, logical, financial sector as we go forward.

Asset quality?

Uday Kotak: Asset quality...on the moratorium of course it’s a black box, but here's my broad view on asset quality. The highest pressure in normal course would be in two categories--unsecured consumer retail and MSME. MSME to a certain extent gets taken care of by the government package, but unsecured consumer financing is still a significant risk that is there in the financial system. And there is no protection for that segment in the economy. That has been, for the financial sector, the fastest growing segment. Independent of this, there is of course the sector issue. Some sectors are more affected than the others, and there will be significant issues in those sectors. Therefore, highly sensitive, Covid-19 related sectors and unsecured consumer financing is where I feel there is vulnerability.

You estimated the potential hit - in your inaugural address you said that there are roughly Rs 100 lakh crore of assets in the banking system with capital of about Rs 11-12 lakh crore. The impact due to loan loss could be Rs 4-5 lakh crore, that's around 40 percent of capital wiped out.

Uday Kotak: That’s broadly my assumption at this point time. I hope it is lower. It is very difficult to predict at this point of time.

And therefore you have urged financial sector entities to raise capital as as quickly as they can, irrespective of valuations. But not all can do that. A Kotak Mahindra Bank has access to investors, what happens to the rest?

Uday Kotak: Even if the valuations are lower, raise capital. Survival and sustainability is more important than percentage ownership.

Do you suspect that there will be structural changes in the banking and NBFC industry...

Uday Kotak: Undoubtably. We are going to see, across sectors not just financial sector, the broader Indian economy, consolidation as an inevitable part of the future.

Can you elaborate a little bit more on what that consolidation might look like at least for the financial sector?

Uday Kotak: I will give you the example of the telecom sector. Thirteen became three. So, I am saying that was intense. Only 25% - 30% survived. I don’t think it will get that intense across different sectors, but it will be a percentage of the total base.

The issue is what does the government need to save? And I will answer your question with a question. Let's look at the airline sector. Does the government, on the margin, need to save airline number five, who ever it is? Or put that money into medium term healthcare? The answer to that question tells you about the future of a consolidated industry.

That might still be all right in airlines or hotels. But that kind of consolidation could be very, very disruptive in the financial sector right?

Uday Kotak: I think the policy makers and regulators have already spoken, I think the RBI has already spoken that they will always protect depositors' money. But what the RBI said without having said it, if I read between the lines, is there is no obligation to protect equity owners' money.

You are envisaging large scale consolidation in the financial sector - banks or non-banking financial companies?

Uday Kotak: I am saying there will be some condolidation, whether it will be large or not so large in many sectors including the financial sector.

Since you made the point about telecom. And this has been a concern of mine. It's not got much to do with Covid, but it will get exacerbated by Covid. By one measure, the top 20 listed companies in this country account for 80% of the profits. How worried are you about this risk concentration, both at the top end, and what it will mean to the bottom MSME layer?

Uday Kotak: I see the future of India as two big categories, one is large, consolidated companies, and the second is younger, startup companies that are small and nimble, eating away market share, really growing out of proportion in a short while. We are talking on one such platform called Zoom: from nowhere to where! We have to be cognizant of the impact of technology, and the speed with which a small company can get large. And that's something that every large company better have sleeplessness over.

Firms which have not figured out which way to go for the future. Large companies will also be vulnerable to the small, sniper attacks which will come from nowhere and establish themselves. And in turn they will become the big companies.

Regarding the suspension of the Insolvency and Bankruptcy Code. There are different views out there. Do you think it's the right move to take, especially for a period of six months to one year?

Uday Kotak: My view is that as of the lockdown date, effectively March 25, a six month window was certainly required. We can debate about the time beyond six months, but six months was required. My understanding of the notification is that it's six months, with an option to go up to one year, starting from March 25, and not from June. So it's not an endless period.

Certainly, six months is what I felt may have been necessary in the context, but longer we can debate. But it's still effectively nine-odd months, if you start from March 25. And, in that context, we also must keep in mind that we are heading for a very different India. We are also in a global context, the world is changing and India needs to protect itself by becoming stronger. Not protect itself by becoming protectionist. I relate to the Prime Minister's message of an 'Atma Nirbhar Bharat' which is competitive and engages with the world.

You said the government should do more. What would be the right timing or timeline that the government should follow in your assessment? Should they wait for some signs of recovery and gauge a month or two down the line what steps are needed? Or wait even longer than that?

Uday Kotak: First, the government has to do whatever it takes, without trying to micro-manage timing on anything that's concerned with short-term lives and livelihood matters. If it means giving money to the poorest of the poor, don't worry about the timing. Let the money go, if required.

With regards to the broader choice between supply-side versus demand-side initiatives, the way I see this curve play out is, as we begin to open up, there will be many areas of pent up demand. There will be sharp rise in demand in the short-run, like a spike, and then it will begin to taper off. The correct time to put the demand inducing measures will be when the spike is done and we are beginning to taper off.