Are Indian Debt Markets In For A ‘Lehman’ Like Crisis?
Apr 22, 2019

Author: PersonalFN Content & Research Team

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When the IL&FS debt conundrum came to light about six months ago, the western media termed it as India's Lehman moment. Since then, the stories of Indian corporate failing to repay debts are unfolding fast. Essel group (Zee-group) and Anil Dhirubhai Ambani Group (ADAG) fiascoes are the latest one.

Many experts are wondering if Indian authorities will need to intervene like the U.S. authorities did between 2008 and 2010.

If you recall, about a decade ago, authorities in the U.S. saved a number of too-big-to-fail institutions. But before that, they allowed the Lehman Brothers to collapse like a pack of cards.

Former Federal Reserve chairpersons had justified Fed's reluctance to save Lehman Brothers citing massive troubles the company faced with its illiquid investments, especially in the real estate portfolio.

Struggling to find similarities between Lehman Brothers and IL&FS?

  • IL&FS, despite being a too-big-to-fail organisation, wasn't as tightly regulated as any other deposit-taking company should be in India.

  • It entered unchartered territories and operated outside its areas of expertise.

  • Importantly, the trouble at IL&FS, just like with the Lehman Brothers, could have been spotted earlier if the lenders had been a little cautious.

  • And lastly, it had no formidable exit plan.

Collapse of Lehman happened prior to the Troubled Asset Relief Programme (TARP) being in place. The U.S. treasury started this programme, TARP, to systematically bailout important U.S. companies by buying their illiquid assets and equity shares.

Will India need a TARP like fund to purge India's troubled financial system?

For now, the government has restricted its intervention in the IL&FS case to ousting the sitting management and appointing nominated members on the board. Nonetheless, the National Company Law Tribunal's (NCLT's) approval to such a move hints at the mismanagement of debt-laden IL&FS.

Now that cases such as Essel group's inability to honour their debt obligations are surfacing, it remains crucial to see whether the government expects lenders to take a knock or chooses to offer financial assistance to crisis-stricken companies. Jet Airways is also making headlines for similar reasons.

Unfortunately, even India's retail investors have exposure to these troubled companies through mutual funds.

Moreover, at a time when investors are bewildered with their debt fund investments, mutual fund houses are trying to play safe.

For example, if a fund house comes to you saying, you will get a part of your Fixed Maturity Plan (FMP) redemption proceeds now and the remaining part might be paid within next six months, but without being able to guarantee that; wouldn't it disturb you?

The other option is you take a knock at your investments and settle for losses, if you want to settle your account immediately.

Wondering who will do this?

Two of India's leading mutual fund houses, Kotak Mutual Fund and HDFC Mutual Fund have done this already. Kotak Mutual Fund has held back proceeds in one of their FMPs and has granted additional time to Zee group promoters to honour their obligations.

According to The Hindu Business Line dated 10 April 2019, the mutual fund industry has an exposure of over Rs 8,000 crore to debt issued by Essel group.

Approximately 55 FMPs collectively have an exposure of over Rs 1,700 crore.

So far, the mutual fund industry has refrained from selling the shares of Zee Entertainment, offered as collateral. The mutual fund houses have allowed Essel group promoters time until September 2019.

On this backdrop, the market regulator had sought explanation from both these fund houses.

[ Read: Regulator May Act Tough Against Undisciplined Debt Funds]

In response, HDFC Mutual Fund released a note recently to back its decision of providing more time to Essel promoters, "Risk-reward seemed clearly in favour of providing additional time to Essel Group. Thus, in the given circumstances, this was the best course of action available with the lenders."

What investors should expect?

As reported by the Economic Times dated 19 February 2019, India has recently surpassed Italy on the bad loan ratios among the major economies of the world. Out of every Rs 100 lent, Rs 10.3 is classified as the bad loans.

Although, many experts claim that the crisis of bad loans is the thing of past now; how would investors be sure of this? After all, the systemic illiquidity has triggered the recent debt fiascoes which have caught mutual funds on the wrong footing.

You can only hope banks affected by the Non-Performing Assets (NPA) won't defer maturity proceeds of your fixed deposits someday, if they meet with asset-liability mismatches.

Market exposure to IL&FS debt is around Rs 91,000 crore. If it fails to monetise its assets and repay investors, it would cause a havoc. Unfortunately, nobody knows how many companies might be unable to repay their creditors in the future.

If the count of such corporate cases increases, IL&FS would be remembered as India's Lehman movement for a long time.

Isn't it an irony that the government talks about inadequate income tax collections terming Indian society as "tax non-compliant", but fails to safeguard the interest of genuine tax payers?

After all, capital infusions in Public Sector Banks (PSBs) and TARP-like programmes are always funded by taxpayers' money.

The saddest part of India's so called Lehman-like crisis is that, investors bear the risk of loss. They are kept on the tenterhooks until the companies can be bailed out with tax revenues of the government.

Isn't there any way to penalise promoters of the company that take the entire financial system for a royal ride?

Many argue, promoters too lose as the market capitalisation of their companies collapse. What if the market capitalisation was created out of thin air by piling on unsustainable debt? No wonder, they offer their shares generously as a collateral.

"Price is what you pay. Value is what you get"-Warren Buffet

In the present scenario, investors are just paying the price for the wrong decisions mutual fund managers had made. There's no value left on the table for them.

Perhaps their only mistake is they sought extra returns when the interest rates were down post-demonetisation. At that time, inflows in debt funds rose exponentially, which found its way to financially unsound companies.

End note

Mutual funds are subject to risk from overconfidence too, besides market risks. You need to be extremely careful when choosing a mutual fund for your portfolio.

Don't know how to select a winning mutual fund? Watch this video to know more...

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