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An Indian sub-prime crisis in the making?

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Socrates

Rohit Azad
Visiting Scholar at the New School for Social Research and Columbia University and Teacher at JNU.
FEBRUARY 05, 2017

https://cdn0.desidime.com/attachments/photos/457589/medium/3955025debt.jpg?1486621461

The share of debt of firms with failing financial health has been going up every year since 2011, leading to mounting NPAs

The Indian corporate sector is grappling with a severe bad debt crisis, and as a result, the banks (public sector banks) are increasingly getting saddled with non-performing assets. Calling it India’s sub-prime crisis might be an exaggeration but I would just like to add ‘not yet’! Moreover in conditions such as these, with the global economic crisis in the background, it’s better to be cautious rather than looking back at the data when it’s all over. This might also help policymakers to take regulatory steps in time to control the contagion before it spreads in the banking system in a big way.

Let’s look at the extent of the bad corporate debt. There are two statistics for a corporate house, which need to be looked at to understand the nature of the debt crisis. One is the amount of bank loans taken in a particular year and the other is whether the firms were financially healthy enough to take the loan in the first place.

Healthy vs ponzi firms
The latter is measured by whether they made enough profits in a particular period to even cover for the interest payments accrued on past debts. As we all know, any loan you take has two parts when the repayment starts: the principal (total loan amount) and the interest accrued on it. For a firm to be financially healthy, just as a family taking a loan, it should make enough profits to cover for both (in financial terms, these are called hedged firms). On the other hand, an unhealthy firm is one which does not even cover its interest payments (the ponzi firm). That the latter should not be given more loans is a no-brainer as that is a sure-shot recipe for disaster. At the heart of the U.S. sub-prime crisis was the fact that loans were dished out increasingly to ponzi households. That’s where the similarity lies. What was true for the household sector could be true for the corporate sector in India.

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Most of the burden of bad loans since 2011 has been borne by public sector banks as opposed to the foreign banks or privately-owned ones

In financial jargon, the health of a firm is measured by what is called the Interest Coverage Ratio (henceforth ICR). It is a ratio of net profits to interest payments due on past debt. It being less than 1 is a danger sign for the lender because it means that the firm is not even making enough profits to pay for its past interest payment commitments let alone the principal amount.

We cover the period between 2011 and 2015 during which this process unfolded in India. We look first at a larger sample of corporate firms with consistent coverage available for these (and some other relevant variables) in the datasets available.

ICR, best metric?
One might doubt whether ICR is the best measure of financial health especially for companies which take longer to generate profits resulting from time lags that assets take to build. In anticipation of this criticism, I present three other variables to present a comprehensive picture of the current corporate debt crisis but interested readers can just look at the ICR to draw their conclusions.

The three other measures are: profitability i.e. whether the firms were making positive post-tax profits; ratio of current assets to current liabilities to measure what part of the liabilities they can pay off if they were to sell their assets; debt to equity (own capital) ratio to measure how much have they stuck their own neck out compared to other people’s money in the risky adventure they are undertaking. The well-accepted thresholds for these measures are 0, 0.5 and 5 i.e. firms which are making negative profits, can honour at least half their liabilities by selling off the assets, while debt is five times as large as own capital respectively. The accompanying Figure 1 presents the share in the debt of such firms in the total sample debt with these individual characteristics over the years 2011-2015.

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Corporate borrowings have risen year-on-year, despite declines in ICRs (<1 in some cases) and high debt-equity ratios, signalling disproportinately high loan burdens

It can be seen from the figure that the share of debt of firms with failing financial health has been going up since 2011. The dotted line represents how the share of bad debt has increased in those firms which could not even honour their interest commitments to the lenders and it has increased significantly since 2012. These are the ponzi firms we discussed above.

Let us now look at something more specific with respect to some big sharks in this respect. We take a sample of four corporations out of the top 10 corporations (in terms of borrowing) identified by the Credit Suisse 2012 report on the House of Debt and follow their trajectory for the same time period as above. Instead of looking at the stock of debt, we focus now on new borrowings during these years because it is possible to argue that if you are not in a position to pay in full the interest accrued, then on that account alone the debt can keep piling up.

What is significant here is that most of these firms were able to not only extract fresh borrowing from the banks but actually increase it even as their status continued to be ponzi! It is for this reason that I call it a potential sub-prime crisis building up.

It can be seen from the Figure 3 that other than Vedanta Ltd., all companies have had at least two years of being in a ponzi state (ICR<1) and yet their borrowings, for most, have increased every year. Let me draw an analogy here. It shows that with increasing diabetic problems in a patient (ICR falling), doctors (banks) are injecting more of sugar (loans) to the body of the patient! Very high debt-equity ratios in the table also corroborates their bad health condition.

Bank NPAs
So far we have seen the story from the culprits’ side. Let us briefly look at the problem from the side of the banks, which has got a lot of media attention especially since the then governor, Mr. Raghuram Rajan flagged this issue initially. As can be seen from Figure 2, most of the burden of bad loans since 2011 has been borne by public sector banks as opposed to the foreign banks or privately-owned banks. The share of stressed loans, which is the sum of non-performing loans and restructured loans, as a percentage of total advances made has been skyrocketing for public sector banks.

In conclusion, while the banks have knowingly put themselves in the current position, the real culprits are the big borrowers and promoters who are not paying up as promised and the government, instead of being strict on the defaulters, is expecting the central bank to inject liquidity into the banking system to write off these bad loans. It would be travesty of justice if this were allowed to be done. It would just give a fillip to the habitual defaulters to default with impunity since the central bank will always be made to come in as the lender of last resort.

http://www.thehindu.com/business/Economy/An-Ind...

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Perfectionist Perfectionist
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Growth begets risk. Sometimes, it pays off. Many a times, it doesn’t.

@A2Zdeals Considering the current global economic scenario, I don’t think it’s wise to be this bullish. What do you think?

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Critic Critic
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Another Goldman-Lehman style fiasco?

Deal Subedar Deal Subedar
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Remember reading in some blog that Demonization exercise was taken up to increase the banks reserve base due to continuously increasing NPAs to avert a crash by taking some more breathing time to fix the ‘Kolkata firms’ (benami or Ponzi firms) in near term with increased digital push for better traceability.

Perfectionist Perfectionist
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@A2Zdeals So being bullish is good in the short term, eh?

Pro Entertainer Pro Entertainer
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medium to long term
short term is like buying TC cards & expecting activation for online transaction in week’s time https://cdn2.desidime.com/assets/textile-editor/icon_toungueout.gif

Critic Critic
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@DealSeeker @A2Zdeals

The topic is about the possible crisis in Indian economy. You guys talk about short term, long term investments. https://cdn2.desidime.com/assets/textile-editor/icon_toungueout.gif

Perfectionist Perfectionist
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What you missed is that investment landscape = economic outlook.

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Perfectionist Perfectionist
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@A2Zdeals 2008 missing from the above picture. https://cdn2.desidime.com/assets/textile-editor/icon_toungueout.gif

Pro Entertainer Pro Entertainer
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you know why https://cdn2.desidime.com/assets/textile-editor/icon_toungueout.gif
outliers are always there & we have to live with it

PS : as a layman i can just say sometimes we don’t like lemon (read lehman) https://cdn3.desidime.com/assets/textile-editor/icon_wink.gif

Deal Captain Deal Captain
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This is far away from my imagination. Can’t understand these things at all. I am shocked how people understand this thing. https://cdn2.desidime.com/assets/textile-editor/icon_rolleyes.gif

Deal Subedar Deal Subedar
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@Magus I didnt say that intelligence is the will to accept or negate. I said that intelligence is to do things as expected of us/machine or as desired by us/machine( in AI cases). Whereas consciousness is the one that wills. A robot that reaches to some logical conclusion will ultimately have to accept that conclusion (Since he has no other way). A machine can never fall out of logic. Even if there is an error, the machine runs by an erring logic whereas a conscious being is always free to chose if he wants to accept or reject that conclusion on his own will.

And I didnt talk about consciousness as an object but as a subject. It can surely not be talked out but a moment of attentiveness or meditativeness and you simply see the watcher (only to be strayed again https://cdn1.desidime.com/assets/textile-editor/icon_confused.gif )

And about the movies I dont think there were really robots in I, Robot. I think they were just crooked men wearing costumes who had gone stray https://cdn2.desidime.com/assets/textile-editor/icon_toungueout.gif https://cdn1.desidime.com/assets/textile-editor/icon_biggrin.gif Anyway a movie can show anything and has nothing to do with real world logic. In movies roses may flower on mango trees https://cdn3.desidime.com/assets/textile-editor/icon_lol.gif

Critic Critic
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Unpredictability? Even a machine can achieve that with more complexity advancing in. That’s what technological singularity proposes as such.

Roses may flower on mango trees but it has to be backed by sound logic, that’s what matters here. Watched Ex Machina ? https://cdn2.desidime.com/assets/textile-editor/icon_wink.gif

Shopping Friend Shopping Friend
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@Magus

What will be the impact of GST on car price on road ??

Deal Subedar Deal Subedar
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I couldn’t fully grasp the ‘whats’ and ‘whys’ of the digressions this thread took….technology, consciousness, taxes and basic commodities…but here goes my 2 cents on the original post.

The complete issue of rising NPAs has been in the public domain since almost a year. From what I understand from economics….Crises and Recessions arise out of an extended period of very good economic growth or war. World War 1 set the stage for the 1930s Great Depression and it was further exacerbated by the administration not doing enough. The 2008 subprime mortgage crisis was preceded by a growth period which encouraged banks to hand out risky loans. And when the recession finally caught up to India, it coincided with the 2G, Coalgate scams and other corruption cases….which inturn sent the govt. into a policy paralysis state and tied up its hands…just when its intervention was most needed…during an economic crisis. An environment of insecurity prevailed and credit dried up, projects failed and NPAs rose after extended deliberation and debt reconstruction periods. Public sector banks were the worst affected because they lacked accountability and the expertise to quickly react to the situation compared to their private counterparts. Many steps have been taken since then and even the current budget provides for capital infusion in a process to elevate the PSU banks to Basel-III international norms. I’m no economics scholar by any standard, but I believe the NPA situation is one of the many aftershocks of the 2008 crisis….not another crisis in itself.

Critic Critic
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Let’s just hope that your words come true. https://cdn2.desidime.com/assets/textile-editor/icon_toungueout.gif

EDIT: @raven_kira At the same time, say something about our politico-economic policies (which are not very different from those of the global capitalists) which remain at the basis of such crises. https://cdn2.desidime.com/assets/textile-editor/icon_wink.gif

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