Yes, IL&FS is bad news but not in the way you think

Commentary so far on the IL&FS crisis has focused on one single fact. The systemic disruption and chaos that an IL&FS collapse would cause if it is not saved soon with fresh capital infusion. Banks would be forced to make provisions, the extent of NPAs within banks and in the system would rise and this would delay and worsen the bad-loan problem that the banking industry is grappling with. Secondly, IL&FS default has sparked mark-downs in debt held by mutual funds which is estimated at about Rs 4,000 crore. Experts fear that an increase in redemption pressures in these funds would cause chaos in the market as funds rush to dump securities at whatever prices they get. This is exactly what happened last week when DSP Mutual Fund sold some papers of Dewan Housing Finance Ltd (DHFL) at 11 per cent yield, much higher than the rate at which it was first sold. Mounting fear that this discounted sale is a reflection of problems either at DHFL or DSP created panic in the markets pulling down the Sensex by nearly 1,000 points in one frenetic session. Fears that banks and mutual funds will stop lending to nonbanking finance companies pummelled shares of these companies adding to the chaos.

Now, some of these fears are probably exaggerated as shown in Tuesday’s debt market trading. Mutual funds continue to invest in NBFCs and housing finance companies, who have come back to the market. Rates have risen a bit but that is only to be expected given the turmoil in the past 10 days. More importantly, mutual funds and banks continue to consider NBFCs as a good investment given that many top-rated ones possess stable, strong balance sheets with little sign of deterioration. If this mood and level of activity sustains, normalcy could return to debt markets in a few weeks. If IL&FS shareholders approve and decide to participate in the rights issue this weekend, the pall of gloom that had descended on markets since last week’s gyrations would be lifted. LIC chairman VK Sharma’s statement on Tuesday afternoon that all efforts would be made to save IL&FS did a lot to bring confidence back but we are yet to hear from other shareholders like Abu Dhabi Investment Authority and Orix Corporation of Japan. HDFC, with about 9 per cent stake, is unlikely to participate in the issue, as the Economic Times reported some weeks back.



The big problem, however, is not with just saving IL&FS. While it would require large amounts of capital and pit LIC at the forefront of yet another rescue mission after IDBI, finding a few thousand crore among some of the biggest institutions in the world and India is not difficult. Fixing accountability and responsibility at IL&FS top management is also not difficult if the shareholders want it that way.

But that is only going to solve the shortterm problem. There still remains a bigger issue and it is this: What does this episode do to infrastructure financing and funding in India? What does the IL&FS example mean to promoters of infrastructure companies looking to raise fundsRs And for banks and investors looking to invest in them?

Whether one likes it or not, IL&FS has become a poster child of reckless infrastructure investment. A series of defaults, nearly Rs 90,000 crore in debt, a tonedeaf management that has allowed this situation to persist, IL&FS has become a symbol of everything that is wrong in infrastructure in the country. The management may blame governments and local authorities and they could be partly right as well, but that does not still answer how a situation like this was allowed to persist for so many years without any attempt at redressal.

This may not be a canary in the coal mine, but yesterday’s failure of North Eastern Electric Power Corp bond issue tells you exactly where investors stand vis-a-vis power and infrastructure investments. The issue was supposed to raise Rs 300 crore, but it got only one bid and guess what was that amount? Rs 13 crore! What makes this all the more ominous is that NEEPCO is a government utility and has sovereign backing. Yet investors were not willing to give money.

Private sector bankers are very clear about what they want to do. Increase retail book, reduce corporate book and unless there are exceptional circumstances, avoid infrastructure lending. Avoid lending in cases where a project requires massive land buying, complex environmental approvals and depends on fuel and other raw material linkages from the government. The massive pile-up in bad loans, caused in many cases by infrastructure and metal investment, the struggles promoters/entrepreneurs to get basic approvals and changed business environment for power means both promoters and bankers are increasingly reluctant to consider infrastructure as a top investment priority.

HDFC Bank CEO Aditya Puri said at a recent ET event that banks would still be willing to fund projects if they are sound and have necessary approvals. “Please don’t forget that we are lending not our money but your money,” he said. But many other bankers are not so hopeful. ICICI Bank wants to increase its retail share of the asset book to nearly 60 per cent. It is already there. Other private sector banks like IndusInd, Kotak and HDFC too have an increasingly high retail share of the book. And this is only going to get worse.

Infrastructure funding in India is probably going to be driven more by government agencies like the National Investment and Infrastructure Fund (NIIF) or foreign outfits like Japanese International Cooperation Agency (JICA). Private sector banks are increasingly going to sit out while public sector banks will become far more cautious. IL&FS may not have started this trend but has definitely worsened it.