What bankrupt Indian business groups can learn from Genghis Khan

genghis khan
Over the last few years, Credit Suisse has brought out an interesting series of reports titled the “House of Debt”. The latest version of the report was released last week.

The report tracks the total debt of 10 Indian business groups which have taken on around 12% of total loans of the Indian banking system. These groups are Adani Group, Essar Group, GVK Group, GMR Group, Lanco Group, Vedanta Group, Reliance ADAG Group, JSW Group, Videocon Group and Jaypee Group.
Analysts Ashish Gupta, Kush Shah and Prashant Kumar make several important points in this report. Here are a few of them:

a) The loans given to these business groups amount to 12% of total bank loans. Further, they amount to 27% of the corporate loans made by banks. In the last eight years the loans of these 10 business groups have gone up seven times. This pace of rise has slowed down in the last couple of years and in 2014-2015, the increase was 5%.

b) The interest coverage ratio of these business groups was at 0.8 in 2014-2015, down from 0.9 in 2013-2014. The interest coverage ratio essentially points to the ability of a company to keep servicing its debt by paying interest on it. The ratio is calculated by dividing a company’s earnings before interest and taxes (or operating profit) during a given period by the total interest it has to pay on its outstanding debt, during the same period.

Typically, companies need to have an interest coverage ratio of at least 1.5, to be considered in healthy financial territory. In this case the ratio is just 0.8. An interest coverage ratio of less than one means that the company is not earning enough to keep paying interest on its outstanding debt. Hence, on the whole, these groups are not earning enough to pay the interest on their debt.

The trouble with any average number is that it does not give us the complete picture. The interest coverage ratios of several groups are well below the average.

The GMR group is at 0.2. The GVK group is at 0. The Lanco Group is at 0.2. The Videocon group is at minus 0.3. And the Jaypee Group is at 0.6.

These business groups are in a very bad situation when it comes to the ability to keep servicing their debt.

c) The interest coverage ratio is at abysmal levels despite a large amount of interest being capitalised, as can be seen from the accompanying table.

As the Credit Suisse analysts point out: “while interest coverage is less than 1, a large amount of interest (15-170% of P&L interest) is being capitalised.”
The Accounting Standard 16 states thatborrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset should be capitalised as part of the cost of that asset.” It further defines a qualifying asset as “an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.”

What this tells us is that the real interest coverage ratios of these business groups are worse than they seem.

d) Given that the interest coverage ratios of these firms are in such a mess, it is not surprising that they are already defaulting on their debts. As the Credit Suisse analysts point out: “Rating agencies have now assigned the default “D” rating to ~5-65% of debt for these groups. For Jaypee Group, almost two-thirds of the group debt is now in the default category including standalone parent company debt. Other groups have also seen multiple defaults at the SPV level for power and road projects.” (As can be seen from the accompanying table)

In fact, the auditors have also highlighted these defaults in the annual reports of these companies. As the Credit Suisse analysts point out: “According to their auditors report, eight of the ten ‘House of Debt’ groups were in default last year. Total debt with these companies in default was at US$53 bn (~48% of total debt with the groups) of which US$37 bn were reported to be in default for 0-90 days by the auditors.” These are not small numbers by any stretch of imagination.

e) Over the last few years, the business groups have tried to repair their balance sheets by selling assets in order to repay their debts. This hasn’t helped much given that in certain cases, the assets that they have had to sell, essentially brought in the money.

Take the case of Jaypee Group. The group has sold assets and these sales are expected to   bring in Rs 22,000 crore. The trouble is that these assets contributed 59% of its operating profit (earnings before interest and taxes) during 2014-2015.

Further, “a large number of projects especially from power and road sectors have seen delays in completion which has led to cost overruns. Some of the projects now have reported cost overruns of 20-70%.

What makes the situation trickier is the fact that “some of the companies have 5-50% of long-term debt (~US$15 bn) maturing within the next year and would need refinancing. Also, 5-37% of their debt is short term (~US$20 bn) that needs to be rolled over.”

What this tells us very clearly that all this talk about general corporate revival needs to be taken with a pinch of salt. A major section of the corporates the infrastructure sector continues to battle the high debt that they had taken on during the go-go years between 2004 and 2011 and are now not in a position to even pay interest on this debt.

Also, it is worth mentioning here that owners of a bankrupt company have no real incentive in acting in the best interests of the company. This is a point that Nobel Prize winning economists George Akerlof and Robert Shiller make in their book Phishing for Phools – The Economics of Manipulation and Deception.

As they write: “If the owners of a solvent firm pay themselves a dollar out of the firm, they diminish the amount they can distribute to themselves tomorrow by that dollar plus its earnings.” Hence, owners of a solvent firm have some incentive to not take out money from it. But that is not the case with the owners of an insolvent or a bankrupt firm.

As the economists write: “In contrast, if the owners of a bankrupt firm take an extra dollar out of their firm, they will sacrifice literally nothing tomorrow.”

And why is that? “Because the bankrupt firm is already exhausting all of its assets, paying all those Peters and Pauls [read banks in the Indian case]. Since there will be nothing left over for the owners, they have the same economic incentives as Genghis Khan’s army, as it marched across Asia: what they do not take today, they will never see tomorrow. Their incentive is to loot.”

Look at what happened to the banks in case of Vijay Mallya and all the money he had borrowed. This also explains why many Indian firms become sick but no Indian industrialist ever becomes bankrupt.

Long story short – banks will continue to have a tough time ahead.

The column originally appeared on The Daily Reckoning on Oct 27, 2015

Some new old lessons on black money

Credit Suisse released the Global Wealth Report earlier this month. The report had some very interesting data points in the Indian context.
As the report points out: “Measured in domestic terms, wealth has grown rapidly in India since 2000 except during the global financial crisis. Annual growth of wealth per adult in rupees has averaged 8% over 2000–2015.” This is a clear reflection of the strong economic growth India has experienced since the turn of the century.

There are some other interesting data points in the report as well. “As in many other developing countries, personal wealth in India is dominated by property and other real assets, which make up 86% of estimated household assets,” the report points out.

It further points out “a very small proportion of the population (just 0.3%) has a net worth over USD 100,000. However, due to India’s large population, this translates into 2.4 million people. India has 254,000 members of the top 1% of global wealth holders, which equates to a 0.5% share.”

Let’s look at the second point first. So India has 254,000 members in the top 1% of the global wealth holders. It is worth remembering here that in his February 2013 budget speech, the then finance minister P Chidambaram had estimated that India had only 42,800 people with a taxable income of Rs 1 crore or more.

Between 2013 and 2015, the number of people with a taxable income of Rs 1 crore or more must have gone up a bit. No new data is available and given that we can assume that the number is perhaps around 50,000.

So, India officially has 50,000 individuals with a taxable income of Rs 1 crore per year. At the same time there are 254,000 members in the top 1% of global wealth holders. There is a huge dichotomy here. The total global wealth as per the Credit Suisse report stands at $250.1 trillion.

Income on which tax has to be paid and accumulated wealth, are two different things. Nevertheless, wealth cannot be built unless an income is earned. And if an income is being earned, some tax needs to be paid on it.

What this tells us is that many Indians are earning incomes, building wealth, but not paying any income tax. A bulk of the “black money” on which tax has not been paid is parked in real estate. And that explains the fact that 86% of personal wealth in India is in real estate and other real assets. In fact, if we look at the 2010 report, the number was at 90%.

This is not surprising given that real estate remains the best parking space for black money. As a FICCI study on black money released in February 2015 points out: “About a third of India’s black money transactions are believed to be in real estate…The real estate sector in India constitutes for about 11 % of the GDP15 of Indian Economy, as these transactions involve high transaction value. In the year 2012-13, Real Estate sector has been considered as the highest parking space for black money.”

The Modi government up until now has been concentrating on chasing black money that has left the shores of the country. After a huge failure on that front, now they have been talking about domestic black money. The finance minister Arun Jaitley wrote on his Facebook page sometime back that “the bulk of black money is still within India”. That should have been obvious from the day the government decided to focus on black money, given that the bulk of black money gets invested in real estate.

Justice (retired) Arijit Pasayat, the vice-chairman of special investigation team (SIT) on black money said something along similar lines recently: “The volume of black money stashed in India is much more than it is now in the foreign countries. If the generation of black money is stopped, its flow to the foreign countries will be substantially reduced.”

The surprising thing is that it took the Modi government nearly 17 months since being elected to power in May 2014 to figure out where the bulk of the black money was inside India and not outside it, something that should have been obvious from day one.

Another interesting thing the report points out is the distribution of wealth among Indians. The top 1% owns nearly 53% of India’s wealth. The top 5% owns 68.6%. And the top 10% owns 76.3%. So what this clearly tells us is that 90% of the country’s population owns less than 25% of its wealth.

Black money has helped increase this inequality. Those who have black money have invested it in real estate and seen their wealth grow at a fast rate. French economist Thomas Piketty calls this the “principle of infinite accumulation” in his book Capital in the Twenty First Century.

Piketty defines the principle of infinite accumulation as the “inexorable tendency for capital to accumulate and become concentrated in fewer hands, with no natural limit to the process.”

This has also led to a situation where all the black money floating around in real estate has led to very high prices of homes, making them unaffordable for those who want to buy homes to live in.

The column originally appeared on The Daily Reckoning on October 21, 2015

Rupee at 65: India Inc in a debt trap just when money is tighter

rupeeVivek Kaul 
During the past few months I have often pointed out the economic mess that the Congress led United Progressive Alliance (UPA) government has landed us into. But that is not the only mess going around. Corporate India is in an equally messy situation on the debt that it has managed to accumulate over the last few years.
Analysts Ashish Gupta, Kush Shah and Prashant Kumar of Credit Suisse in a report titled 
House of Debt – Revisited, dated August 14, 2013, put out numbers showing the same. They estimate that the gross debt of ten Indian corporate groups for the financial year 2012-2013 (i.e. the period between April 1, 2012 and March 31, 2013) stood at Rs 6,31,024.7 crore. Their debt has risen by 15% over the financial year 2011-2012 (i.e. the period between April 1, 2011 and March 31, 2012).
Interestingly, in the financial year 2006-07( i.e. the period between April 1, 2006 and March 31, 2007) the gross debt of these groups had stood at Rs 99,300 crore. So their debt has increased six fold in the period between March 31, 2007 and March 31, 2013.
And this has landed these groups (which include the likes of Videocon, Adani, Essar, JSW, Reliance ADA, Vedanta, GMR, GVK etc) into serious trouble. The overall interest coverage ratio of these groups as on March 31, 2013, stands at 1.4. The interest coverage ratio is essentially a measure of the capability of a company to pay interest on its outstanding debt. It is calculated by dividing a company’s earnings before interest and taxes (EBIT or operating profit) for a year by the interest to be paid on the outstanding debt for the same year.
An interest coverage ratio of 1.4 essentially means that for every Rs 1 of interest that the company has to pay, it makes Rs 1.4 of operating profit. This basically means that around 71.4%(1/1.4) of the operating profit of the ten groups cited in the report, will go towards interest payment. This is a very tricky situation to be in.
The interest coverage ratio of the ten corporate groups cited in the report has dropped from 1.6 as on March 31, 2012, to 1.4 as on March 31, 2013. What this means is that as on March 31, 2012, these groups would have had to pay 62.5% of their operating profits to pay interest on their oustanding debt. That has now jumped to 71.4%.
In fact, some of the groups have an interest coverage ratio of less than one. This basically means that they are not making enough money to repay the interest on their debt. As the Credit Suisse analysts point out “Aggregate interest cover for these top ten groups has dropped from 1.6x to 1.4x. Interest cover ratios at groups such as Essar, GMR, GVK and Lanco are already under 1. Interest cover at Adani and Jaypee have also fallen to <1.5x. Interest coverage ratio has come down from 1.2x to 0.6x for Lanco Infratech…Similarly, for GVK infra, the coverage ratio has come down from 1.0x to 0.4x.”
In fact the situation gets much worse if one takes into account the fact that the groups are currently not expensing the entire interest cost in their profit and loss account. This is because the money raised through debt has been used to construct projects. A large part of these projects are currently under construction and haven’t come on stream. Hence, a lot of interest is currently being capitalised, which basically means that it is being shown on the asset side of a balance sheet and hasn’t been shown as an expense in the profit and loss account.
As the Credit Suisse analysts point out “ As most of these groups have capacities under construction, a large share of interest expense is also currently capitalised. With capitalised interest currently 30- 250% higher than the P&L expense, the interest burden may also sharply rise as projects come on stream.”
Take the case of Reliance Power. The company is currently showing an interest of Rs 580 crore in its profit and loss account. At the same time the company has a capitalised interest of Rs 1470 crore. Once this interest moves from the balance sheet to the profit and loss account, the interest coverage ratio of the company will fall from 2.4 to 0.7. This basically means is that the company will not make enough of an operating profit to pay the interest on its outstanding debt.
The depreciating rupee has been adding to the problem because a huge proportion of the oustanding debt of these corporate groups is in foreign currency. “Many corporates’ loans are 40-70% foreign currency denominated; therefore, the sharp depreciation in the rupee is adding to their debt burden. Adani Enterprise and Reliance Comm have the largest percentage of borrowings through forex loans,” write the analysts.
One dollar was worth around Rs 55 in mid May. Now it is worth around Rs 65. Hence, this means that these corporate groups will have to pay more rupees to buy dollars to repay their foreign currency loans.
India’s external debt as on March 31, 2013, stood at at $ 390 billion. Of this nearly 79% debt is non government debt. External commercial borrowings(ECBs) made by corporates form nearly 31% of the external debt. This is not surprising given that the Credit Suisse analysts point out that 40-70% of the loans of the 10 corporate groups that they studied are foreign currency denominated. As these loans mature in the time to come corporates will need dollars to repay them, and this will put further pressure on the rupee.
What makes the situation more scary is the fact that ECBs of $21 billion raised by corporates need to be repaid before March 31, 2014. Corporates which are in a position to repay earlier, will make a dash for it. This is primarily because as the rupee depreciates against the dollar, a greater amount is needed to buy dollars.
So if companies have idle cash lying around, it makes tremendous sense for them to prepay foreign currency loans. The trouble is that if a lot of companies decide to prepay loans then it will add to the demand for dollars and thus put further pressure on the rupee.
All this debt, also means that the situation can’t be good for Indian banks which have lent money to these corporate groups. As analysts Ashish Gupta and Prashant Kumar of Credit Suisse pointed out in report titled 
House of Debt and dated August 12, 2012, “Over the past five years, Indian banks have witnessed strong (20% CAGR) loan growth. However, this growth is increasingly being driven by a select few corporate groups. In FY12, over 20% of the incremental loans came from just ten groups. The total debt level of these ten (Adani, Essar, GMR, GVK, JSW, JPA, Lanco, Reliance ADA, Vedanta and Videocon) has jumped 5 times in the past five years (40% CAGR) and now equates to 13% of the total bank loans and 98% of the net worth of the banking system.” The situation could have only gotten worse for Indian banks since then.
Of course the question is how did the big Indian corporate groups land up in this mess? 
As a recent report in The Hindu Business Line points out “Between 2002-03 and 2007-08, private corporate investment as a percentage of India’s GDP rose from 5.7 to 17.3. Subsequently, it fell to 13.4 in 2010-11, but was still higher than the single-digit levels till the early 2000s. The above investment binge was significantly financed through large-scale borrowings, contracted with the confidence that the projects executed would generate sufficient returns to service the debts. Moreover, the large differential between domestic and overseas interest rates, besides the belief in a perennially strong rupee, emboldened corporates to increasingly resort to ECBs (external commercial borrowings).”
Interest rates in India over the last few years have been higher in comparison to interest rates abroad. This is primarily because the Reserve Bank of India had been raising interest rates to tackle inflation. At the same time the Western Central banks had been running easy money policies where they were printing and pumping money into the economy. With a surfeit of money going around interest rates abroad were thus lower, leading to the Indian corporates borrowing abroad rather than in India.
The government helped corporates in this borrowing binge. As 
The Hindu Business Line report cited earlier points out “All this was further actively encouraged by policy makers at the Finance Ministry, RBI and Planning Commission. Among other things, corporates were permitted to access up to $500 million of ECB under the ‘automatic approval’ route every year, which got subsequently enhanced to $750 million.”
But now with the rupee rapidly against the dollar, all this debt will end up creating huge problems for these overleveraged corporate groups. One way out of this mess is by generating money through the sale of assets that these groups have. The trouble here is that who do they sell to? As the Credit Suisse analysts pointed out in their August 2012 report “Given the high leverage levels, poor profitability and pressure from lenders, virtually all of the ten debt-heavy groups have initiated to divest part of their assets (cement plants/power/road projects). However, given that most of the domestic infra developers are already over-geared, demand for these assets may be limited.”
The chickens, as they say, will come home to roost for India Inc.
The article originally appeared on www.firstpost.com on August 23, 2013 

(Vivek Kaul is a writer. He tweets @kaul_vivek)