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The Government of India cannot go bankrupt, for it has the monopoly privilege of printing money. The banks it owns cannot go bankrupt, for the government can give them as much printed money as they need. But their clients can go bankrupt. It happened before, in the 1980s; to deal with the crisis, the government enacted Sick Industrial Companies Act in 1985. The Act did not lead to much recovery of loans. Then the government enacted the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act in 2002. The cases filed under it have been winding through debt recovery tribunals. The beautiful industrial boom of 2004-08 did more to resolve the problem than SARFAESI; it lifted many companies out of their financial troubles and enabled them to pay off banks.
But the possibility of another debt crisis can never be dismissed. Right at the moment, the economy is slowing down. The seriousness of the situation can be gauged from the frequency of upbeat statements being made by a succession of finance ministers before each goes on to lighter duties. How likely is another liquidity crisis? And whom will it affect? These are questions to ask now. And thanks to the banking crisis in the US, a technique has been developed to predict what would happen; it is called stress analysis. The International Monetary Fund’s India Country Report 09/186 presents a stress analysis of Indian companies which deserves serious and critical reading.
Indian companies on the average have considerable financial strength. Their 2007 return on assets of 17 per cent was higher than the 12 per cent in Latin America and 7-10 per cent in industrial countries. Their debt equity ratio of 0.6 was comparable to that in Asia and America. Only a fifth of their debt was foreign, and only 15 per cent of the companies had borrowed abroad. Their gross profits were enough to cover interest payments, much higher than in other developed and developing markets. But these are only averages. What is important to the measurement of risk is the fact that the debt service costs of 22 per cent of the companies exceeded their profits, and that they owed 15 per cent of the total debt.
But a comparison of interest payments and profits overestimates the risk since companies can fall back on resources beyond profits, especially on reserves and fresh equity. A better way of assessing the risk is to estimate the impact of particular imagined adversities. On the basis of such an exercise, a rise of 5 per cent in the domestic interest rate would stress 12.6 per cent of the companies owing 8 per cent of the debt. A rise of 7 per cent in foreign interest rates would stress 1 per cent of the companies owing 3.6 per cent of the debt. A rupee depreciation of 25 per cent would stress 0.1 per cent of the companies owing 1.6 per cent of the debt. And a fall in profits of 25 per cent would stress 5.9 per cent of the companies owing 4.6 per cent of the debt. If all these catastrophes occurred together, they would stress 21.3 per cent of the companies owing 19.8 per cent of the debt — figures very close to those arrived at by the earlier method. A decline in market equity valuation also does not have much impact on the companies.
Managements of individual companies would be familiar with the results of such stress tests done on their own accounts, and would have more up-to-date figures; they would be taking defensive action in response. There is not much they can do in defence, except to marshal liquid resources that can be used in the event of adversities.
The results are more useful as a guide to policy. What they indicate is that the overseas exposure of Indian companies is small. They are, therefore, less likely to be affected if economic conditions worsen in the West; and the government has relatively more freedom of manoeuvre in its exchange rate policy than its domestic policies. In particular, the companies would be extremely sensitive to a rise in domestic interest rates. The government has, therefore, been right in trying to bring interest rates down, and would be right to continue using interest rate policy for moderating the downturn.
The risks faced by companies are of a low order. Far more disturbing is the IMF’s estimate of the macroeconomic impact; the growth rate of the gross domestic product could decline to 4.6-6.2 per cent — far below the figures repeatedly put out by the government, and not much out of line with the latest quarterly figures. The current downturn is likely to be much deeper than the government is prepared to contemplate.
(Businessworld Issue Dated 30 June-06 July 2009)