Passing the buck

The fall of IL&FS is a story of enlisting the private sector to facilitate ease of living without ensuring ease of paying the bill

The mimicking of the Satyam Computer Services model to take over IL&FS is intended to assure the market that the crisis will be contained swiftly. The tech services exporter was sold within four months after the Union government bundled out the discredited board. A finance ministry official has put the bailout timeline for the cash-strapped financier and developer of infrastructure at six to nine months. The improbable feat seems to have succeeded for now. Save for one mutual fund, there was no mass-scale dumping of debt, belying fears of a contagion. Though similarities are sought to be drawn, the two cases are different. The promoter-driven software solutions provider’s problem was not with liquidity but its deployment. The fallout of the collapse was restricted to its stakeholders as was in the case of a non-performing airline and some steel makers. Accountability could be fixed. In contrast, no single institution controlled the resources-hungry showcase of public-private partnership that absolved the government from raising funds for execution and maintenance of bare-bones projects. Lenders include financial institutions, banks, NBFCs and mutual funds. Operations span across geography and involve numerous participants. Despite maintaining an arm’s length, the government is an indirect shareholder. Satyam dressed up earnings to retain a slot among the top three players in the sector. IL&FS’s illiquidity stemmed from pending receivables, resulting in defaults. While the desperation to scale up contributed to Satyam’s demise, the obstacles for IL&FS were not bagging orders but implementation and payment delays.  Handpicked directors being ignored by a founder cooking the books is understandable. What is not is the passive role of two foreign big-ticket investors, a poster-boy for transparency and state-owned entities even as professional managers without skin in the game recklessly piled up short-term debt. The ejected nominees represented government-controlled entities as well as the private sector. The plumbers replacing them are drawn from bureaucracy and deal makers.  

.

 If the chief of a mortgage pioneer was penciled to find another home for Satyam, a new-age banker has been entrusted to staunch the bleeding of the IL&FS group, excise the infections and wrap it up in an attractive package. Despite a record of wealth-creation, it will not be out of place to wonder how much time an owner, who is in the midst of reducing his stake by the December 2018 deadline to comply with regulations, can devote to his flagship from an honorific job. Not only that, the issue is of enlisting someone who has been pulled up by the monetary watchdog, for trying to bypass the dilution of his holding by issuing preference shares, to rescue a sinking ship whose corporate governance practices are responsible for the mess it is in. Instead of one enterprise, he will have to reckon with over 300 listed and unlisted subsidiaries, associates and joint ventures with a web of cross-holdings. A company doing generic back-office work is bought for its client roster to expand market share. In contrast, the challenge for the new buyers of assets, floated mostly by special purpose vehicles, is to make them revenue-accretive. Rather than trying to plug the leakage, what is required is disentangling and slicing and dicing of the IL&FS group so that it can be disposed of piecemeal.

More than survival, the preoccupation of the fire-fighters will be to open lines of credit to extinguish the likely redemption pressure. The issue in Satyam was not of de-leverage but of restoring confidence. The Rs 91000-crore liability of IL&FS is a collateral damage of a hybrid monster, created by the government to snag private capital for local body projects, gone out of control. In turn, the policy makers could conveniently shrug off the responsibility to boost tax revenues to support the demand for world-class facilities and, at the same time, not muster courage to make users pay for them. Retail finance companies get assured monthly returns on their assets. Apart from collection of toll over a fixed tenure, other essential but capital-intensive projects such as water treatment do not generate annuity. The one-time payout hinges on release of funds from the sponsor, often municipalities and Central and state undertakings hobbled by the need to provide subsidies and free services. Now that the experiment has backfired, the government has two options. It can take the exposure on its book by subscribing to the NBFC’s bonds. The alternative it to disallow the beneficiaries of the services a free run. Not all the woes of IL&FS are of its making. Its misfortune is being present in a sector that promises ease of living but does not assure ease of paying the bill.       

-Mohan Sule

Against conventions

Investments tracking economic expansion and mimicking institutional investors have to reckon with higher costs

It takes a crisis for investors to realize the uselessness of conventional theories. A track record of expanding revenues and profit, a sound dividend policy, transparency in operations, prompt disclosures, shunning discrimination against the small shareholders, standing out in comparison with peers, good liquidity and presence of institutional investors are high on the checklist. It is rare to find a stock that has all these qualities. Gain in market share is often at the expense of the margins. A low base can push up profit in a year but becomes difficult to sustain going ahead unless debt is taken to grow organically or through acquisition. Cash accumulation creates unease about the longevity of the niche position in the event of technological disruption going ahead. Instead of imparting a sense of security, deployment of cash becomes a concern. Promoter control offers solace about continuity as well as discomfort over sudden change of direction. If foreign and local fund holdings are tracked to validate the correctness of the investment decision, their contradictory behavior during the recent market turmoil has caused confusion rather than resolve the issue of using these big-ticket investors as the guiding pole. Overseas portfolio investors have exited while mutual funds stayed put in stocks. The question is whose actions should be considered a reliable indicator of the outlook for a company.  Investors mimicking the footsteps of institutional investors have to prepare to churn their portfolios along with these leaders. Trading expenses and taxes can eat into the gains.

History is rife with the futility of policy makers trying to shape the movement of liquidity to maintain the growth momentum and at the same time exercise fiscal rectitude. During the Great Depression of the 1930s, the US limited credit and cut down expenditure. It took a decade for the global economy to recover from the risk-aversion. The controls imposed on the surging fund inflows into the Asian Tigers to tame prices of assets triggered the first currency crisis in 1998 after the formation of the WTO to facilitate seamless trade. In contrast, the dot-com boom and bust at the turn of the century resulted in loose monetary policy by the Federal Reserve, clearing the way for the global financial meltdown in 2008. Ironically, the seeds of the present turmoil in the foreign exchange market can be traced to the US central bank embarking on an opposite path of money-tightening. The more the Fed raises rates, the more is the intensity of the flight of funds back to the US, weakening the emerging economies and disheartening those betting on a strong US economy boosting exports and inward investment. The effort of India to discourage imports of non-essential items by raising tariffs is a classic throwback to a bygone era but has the capacity to make indigenous manufacturers attractive. The contrasting step of easing foreign investors’ access to corporate debt is an out-of-the-box move to meet the resources need of a growing economy and at the same time check the fall of the rupee. What it means is that henceforth the problem-solving playbook will be a mixture of traditional and innovative solutions, throwing into disarray the usual preference for companies with FDI over external debt. 

A sprinting economy is known to light the fire of inflation as supply lags demand. Those taking positions to capitalize on the consumption story have to keep in mind the heavy-handedness of the central bank. The obsession of the Reserve Bank of India with heating prices was taken to a new level by former governor Raghuram Rajan. He kept the lending rate at 8% throughout 2014 even though the new peg to benchmark the policy rates, consumer inflation, composed mainly of food items, halved from 8.1% in the year. The Wholesale Price Index, with predominance of the core and manufacturing sectors, was negative in 2015. The repo rate was 7.5%, when the headline CPI was 5.3%, in March 2015. By the time he left a year later, the headline WPI was 1% and CPI 5.2%. Yet, the base rate remained at 6.25%. In the process, growth slumped from 8.8% in the September 2014 quarter to 7.6% two years later. The downside of tracking the GDP to get ready to invest is confronting stocks preparing to sprint being weighed down by higher operating costs. Recent events have also demolished the strategies of buying at dips and picking stocks with tailwinds. Cheap forward valuations have proved illusionary as promising stocks crash-landed not because of sudden transformation in the marketplace but on unexpected corporate governance issues. Attractive trailing discounting becomes deceptive when the company’s problem is not cyclical but arises from misjudging the market.     

Mohan Sule