IL&FS Died One Year Ago, But Its Pain Is Alive And Throbbing
Killing IL&FS created an awful trade-off: it saved Rs 25,000 crore, but destroyed Rs 25 lakh crore, writes Raghav Bahl.
The financial sector dreads September, the month that has just gone by. In 2001, the twin World Trade Center towers in Manhattan were struck by two commercial aircraft, shutting the NYSE and Nasdaq for a whole week. In 2008, Lehman Brothers collapsed, paralysing global markets. Last year, IL&FS defaulted on its debt obligations, seizing India’s shadow banks. For one year now, Dalal Street has been gripped by a death wish, which culminated in the bizarre case of Altico Capital – last month, in September!
Altico’s story is surreal. It’s an unlisted non-banking finance company founded by three global giants who manage world-wide assets of nearly $300 billion. Altico itself has over Rs 500 crore in equity and Rs 3,000 crore of net worth. Its profits in Q1FY20 were over Rs 75 crore. The company had more than Rs 550 crore in cash – yes, in cash. And yet it defaulted on a paltry interest payment of under Rs 20 crore to Mashreq bank. Yes, under Rs 20 crore. Bizarre, right?
A similar defeatism has gripped India’s financial markets ever since the government treated a systemically-important financier as if it were a shoe or biscuit company! “IL&FS is a private entity; the government should not back-stop its defaults; let the bankruptcy system work itself out” was the refrain on Raisina Hill.
Killing IL&FS Created An Awful Trade-Off: Saved Rs 25,000 Crore, Destroyed Rs 25 Lakh Crore
Right or wrong, IL&FS (like UTI in 2001, which was remarkably bailed out by the Vajpayee government), was seen to be a quasi-sovereign entity, owned and controlled by a clutch of public sector behemoths, including SBI and LIC. It had already defaulted several times in the weeks leading up to that fateful closure in September 2018. While its debt was nearly Rs 1 lakh crore, it needed to repay a mere Rs 35,000 crore until March 31, 2019. It could have hastily sold equity and assets of around Rs 10,000 crore, leaving it short by Rs 25,000 crore. Since its operating cash flow was negative, it needed a bailout.
Otherwise, the contagion would have been – and unfortunately, it was – devastating. Within weeks the markets wiped out Rs 10 lakh crore of investors’ wealth. The credit economy gummed up. Beleaguered public sector banks had a direct exposure of Rs 40,000 crore in term debt given to IL&FS. Provident and pension/insurance funds had an additional Rs 30,000 crore at risk. NBFCs, mutual funds and others were staring at a write off equal to the balance Rs 20,000 crore.
That was not the time to argue nuances around moral hazard. That was the time to hoist the fire hose, and spray calm into the markets.
The government had a plethora of options:
- It could have created a superior debt/equity instrument for the National Infrastructure and Investment Fund, which could have installed a brand-new management and overseen an orderly rescue, including asset sales over the next few months or years.
- Alternately, it could have quickly calculated the vastly denuded Net Asset Value of the company and floated a rights issue of shares at half that value. For example, if the NAV had halved after the bad assets were written off, the rights issue would have happened at a quarter of the NAV on the balance sheet before it blew apart. I am sure IL&FS’ pedigreed shareholders (or others) would have jumped at the mouth-watering valuation, especially if they were assured of a public listing within a year.
Whichever option was chosen, the defaults had to stop. And once order was restored, the regulators would have begun the arduous process of systemically reforming, and holding accountable, everybody who messed up in this saga, from the founders, directors, ratings agencies, the fragile apparatus of using short-term finance to fund long-gestation infrastructure projects, whatever!
So, what were the lessons the government should (and perhaps still can) learn from the IL&FS meltdown?
One: systemically important finance companies inflict an exponential damage if not rescued; refer to the commentary on TARP, below.
Two: overall economic welfare increases if finance companies are saved, since a general, cross-sector pain/slowdown is pre-empted.
Three: there is a moral hazard only if wayward owners are given a lifeline instead of being punished; but there is a moral benefit if the underlying asset is saved, even as unscrupulous founders/managers are taken to the cleaners.
TARP: Why did an Acronym-Loving Modi Government Ignore These Four Letters?
Picking up lessons from our IL&FS fiasco, I have advocated a TARP-like rescue plan for systemically-important-but-stranded assets in our economy. Let’s begin with a bit of history. Lehman filed for bankruptcy on Sept. 15, 2008. Markets plunged, threatening the global economy with a disorderly collapse.
Cash given under TARP was neither a grant, nor a subsidy, but an investment which the companies had to pay back with an appropriate return. Yet, the Congressional Budget Office initially estimated that $356 billion (out of the $700 billion) would be irretrievable, to be written off; but the lawmakers were happy to burn this cash to save their economy. They understood that the promise of cash-on-tap would obviate a systemic meltdown.
How I wish the Modi team had the same understanding of market psychology!
How Successful Was TARP?
Since it’s impossible to argue for the negative, i.e. to assess how much damage would have occurred if TARP had not been promulgated, we can only rely on guesstimates. A study by Alan Binder and Mark Zandi showed that U.S. unemployment could have touched 16 percent (it had peaked at 25 percent in the Great Depression of the 1930s).
Prime Minister Modi, in his new avatar as dramatic tax cutter/reformer, should make the TARP Handbook a mandatory text for his economic advisors.
Raghav Bahl is the co-founder and chairman of Quintillion Media, including BloombergQuint. He is the author of three books, viz ‘Superpower?: The Amazing Race Between China’s Hare and India’s Tortoise’, ‘Super Economies: America, India, China & The Future Of The World’, and ‘Super Century: What India Must Do to Rise by 2050’. BloombergQuint.