Resolving the bad-loans puzzle

Major television channels tell us that the government is likely to take the bull by the horns and tackle banks’ non-performing assets (or NPA) problem squarely. Considering that the “twin balance sheet” crisis is at the root of muted investment sentiment, and therefore suppressed job creation, it is necessary to deal with this at the earliest. However, it is important to understand the totality of the problem first.

Projects that were conceived and funded in the period of high growth prior to the global economic meltdown in 2008 were premised on the belief that the Indian economy would have a free run for several years. No one — policy-makers, regulators, promoters, lenders — considered the possibility of a sudden meltdown followed by a prolonged period of depressed economic growth globally. India did try valiantly to stay afloat, with the government stepping up to the plate with three successive stimulus packages, which created another set of problems, but by 2011 the global crisis finally caught up with the Indian economy and the rest is history.

Large infrastructure projects, mostly well-designed public-private partnerships (PPPs), started getting stressed and that resulted in falling revenue receipts, equity getting wiped out and debt servicing capacity getting eroded. In other words, the projects ran out of fuel and were stranded. Several attempts were made to bail these out through debt restructuring, mostly as the lenders had very little hope of recovering loans fully because of the overall economic slowdown and erosion of the projects’ net worth. Some promoters may have leaned on their political benefactors to bail them out, but these numbers were not very large.

By 2012, the Union finance ministry had swung into action and decisions were being taken to put the economy back on track. On easing the banks’ balance sheets too, certain policies were announced with appropriate regulatory backing. One such scheme was that of infrastructure debt funds (IDFs). The IDFs were established primarily by private finance companies as an instrument of take-out finance. Some banks also participated.

IDFs were “tax smart” and could restructure loans after buying these from the banks. Loans could be stretched to fit the project life cycle by spreading the debt service burden over a longer period than available through the banks due to asset-liability mismatch. The cost of finance from the IDFs was also expected to be cheaper, as the construction risk is over in most cases. These were designed to “buy out” the debt of infrastructure projects, which were clogging up the banks’ balance sheets, to create head room for them to start lending to new projects. However, IDFs can buy out only projects that are rated AA or higher. The IDFs have done reasonably well but did not help in the case of stressed assets.

In 2014, when the new government took over, Finance Minister Arun Jaitley was from the very outset very keen to tackle the problem of stressed assets on a priority basis. Therefore, the department of economic affairs was asked to come up with some concrete ideas that could be announced in the budget. Mr Jaitley announced the launch of the National Infrastructure Investment Fund (NIIF), with an initial capitalisation of Rs 20,000 crore, in his maiden Budget speech. The idea was borrowed from the Troubled Asset Relief Program (TARP) of the United States.

When the global crisis caught up with the Indian economy in 2011, promoters of many large infrastructure projects saw an erosion in their debt-servicing capacity 

It was expected that NIIF, which would be managed through a PPP structure with a professional management, would buy into the equity of the special purpose vehicles (or SPVs) of large stressed infrastructure projects at fair value, thereby infusing much-needed equity. Wherever it deemed fit, it could change the management. With these changes, banks would have greater comfort to restructure debt. Haircuts would have to be taken by both promoters and lenders. Over time, these SPVs would be listed and when the project had been restored to good health, the NIIF would sell the shares in the market at a premium and exit. The NIIF has morphed into something else and a good opportunity was lost.

The solution under the government’s consideration must address the question of equity and debt simultaneously. Going back to the original idea of the NIIF may be the need of the hour. On the debt side, IDFs could be tweaked to buy out the debt of stressed assets in cases where the NIIF has bought into the equity. However, two factors would have to be dealt with: First, the IDFs can only step in efficiently if banks take a haircut, as the assets are stressed. Banks may be unwilling to consider this because it could attract allegations. They may not be wrong, because recently we have seen some former top bank managers being arrested for loan-related decisions.

The NIIF could hire professional help to assess the extent to which haircuts on the part of lenders and promoters is warranted, in order to help empowered bank boards take decisions without looking over their shoulders. The oversight of this process by agencies such as the Central Bureau of Investigation and the Central Vigilance Commission would of course have to be considerably restrained. The “holy trinity” of the NIIF, IDFs and a credit enhancement fund could be the solution.
 

The writer is former Finance Secretary and Chairman, CUTS Institute for Regulation & Competition