»5 Minute Wrap Up by Equitymaster

On This Day - 18 MARCH 2013
Is lack of bankruptcy law hurting India?

In this issue:
» Cyprus - the latest problem in Euro zone
» S-curve evident in Indian telecom sector
» Is Greenspan once again making wrong predictions?
» Why are oil majors ignoring Iraq ?
» ...and more!

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"If you owe the bank Rs 100 that's your problem. If you owe the bank Rs 100 m, that's the bank's problem!" None other than the Indian banks that have lent money to Kingfisher Airlines know this better. After all, the absence of a bankruptcy law in India has made recoveries impossible from the long defunct airline. Moreover, the management is still feigning the possibility of a turnaround. Had Mr Mallaya incorporated Kingfisher Airlines in the US, it would have long been subjected to Chapter 11. But the absence of an equivalent bankruptcy law in India has allowed many Indian companies to dupe their banks and investors.

Now it is not unusual for even big companies to run into rough waters.But having done so they need to evaluate the possibility of a turnaround. In most cases the turnaround is very painful with the company having to part with critical assets and employees. But at least that ensures some hope of sustenance. It also assures the bankers and investors of the possibility of recovering their money.

American legal code allows companies unable to service debt to reorganize themselves under bankruptcy protections. This is commonly called Chapter 11. The restructuring activity may warrant sale of assets, cut back in salaries and pensions, and temporary moratorium in loan repayments. While doing so the businesses can continue to operate. India's banking system too operates a corporate debt restructuring cell (CDR). But the difference between Chapter 11 and CDR is that the latter is voluntary and far more lenient. In the case of CDR it is the banks that need to negotiate with corporate on loan repayment terms. In most cases the interest on the same is partially or completely waived off. Investors like shareholders have little hope of recovering their money only in the event of a successful turnaround. However, many entities have in the past managed to restructure operations successfully by going through the CDR cell. Pharma major Wockhardt is all set to exit the cell having successfully revamped the business. Suzlon Energy reluctantly entered the cell this year having failed at all other attempts of recovery. But there are managements like that of Kingfisher Airlines that refuse to acknowledge the problem. Given the massive quantum of debt, the banks and shareholders therefore become the victims of business failure. As per Financial Times, veteran banker and chief of HDFC Bank, Mr Aditya Puri believes that it is a high time India has its own bankruptcy laws in place.

Indian banks have been struggling with the problem of bad loans for quite a while. Heavy loan write-offs have impaired the profitability of the biggest and most profitable banks in the system. However, the government refuses to see an end to the problem. While on one hand restructured agriculture loans have piled up bad assets in the books of PSUs banks. On the other, unwilling corporates have chosen to default on loan payments rather than restructure their businesses. Lack of legal redressal for banks and investors by way of bankruptcy law has accentuated the problem. Hence we agree with Mr Puri's views that bankruptcy laws will dissuade entities like Kingfisher Airlines from evading legal recourse.

Do you think India needs a bankruptcy law like Chapter 11 in the US? Please share your comments or post them on our Facebook page / Google+ page

 Chart of the day
A concept you learn in the business schools is that of the S-curve. It typically portrays the life cycle of a product, technology or even an industry. So the life cycle is characterized by the initial or the development and introduction phase, followed by a growth phase. Eventually the growth wanes as the industry enters its maturity stage and eventually declines. The chart shows us that the telecom industry in India is entering the maturity stage. If we look at the way the penetration level has moved, it would certainly appear that the telecom industry is in the top end of the S-curve. Overall tele-density in the country stood at 77.04% at the end of September 2012. Therefore the rate of increase in subscribers is only going to slowdown. This would mean that the kind of explosion that we had seen in the telecom sector in the past is unlikely to return at least on the subscriber front. The one thing that can drive growth is change and up gradation of technology. But given the government restrictions and regulations, this driver has not really kicked in as of now.

Souce: TRAI

No sooner do the authorities in the Euro zone try to quell one problem, another one comes to the surface. Well, the tiny nation of Cyprus seems to be the point of origin of the latest problem to hit the Euro zone. Apparently, due to the bad loans made by its banks, Cyprus is on the verge of an implosion. And it desperately needs money to keep its banking system functional. And while the funding may not be difficult to find, it comes with a strict rider. Cyprus itself will have to pitch in with around 40% of the money if it is to get the remaining 60% in the form of bailout funds.

And it is here that everything can come crashing down. Since its coffers are empty, Cyprus has hit upon this unique idea of taking a bite out of each and every deposit account in the country and thus raise the bailout money. However, it didn't take long for the stupidity of this idea to become evident. Citizens of the country lined up at cash machines as their faith in the banking system took a huge beating. And there are howls of protests even outside the country's shores. Many experts are already terming the move as a dangerous precursor to how bailouts are likely to be handled in the future. Thus, those who were thinking that we are well past a full blown crisis, a serious re-thinking certainly is in order.

In recent times, the US stock markets have been on fire. The Dow Jones Industrial Average Index recorded a historic winning streak. Something it has not done since way back in 1996. This has led many to question whether the run up is only fuelled by the cheap money being printed by the US Fed. But ex Fed Chairman, Mr Alan Greenspan does not seem to agree with this view. He thinks that the run up in stock prices is purely due to the reduced fears surrounding the Euro zone. This means that there is no irrational exuberance driving stock prices.

Is he wrong when he says this or are the other market experts wrong? Well the troubles in Eurozone are really far from over. Their bailout programs are just postponing the crisis and not resolving them. Moreover the US economy is still not out of the woods either. Therefore all signs point that the recent run up in stock prices is due to the Fed money printing and not due to fundamental reasons. In all likelihood Mr Greenspan is as wrong about the stock markets as he was about the housing markets in 2008. That time he did not think there was a housing bubble but was later shocked when the crisis unfolded. Maybe when the stock market bubble bursts this time, he will be 'shocked' all over again.

A decade has passed since US unleashed a war on Iraq. Those who have blamed US for attacking Iraq for its oil assets must be feeling at a loss of words post the ironical outcome of oil licensing round held by Iraq last May. The Western oil companies' lack of interest in Iraq's oil assets is too obvious from the poor attendance in fourth licensing round; in which none of the companies bid. So what has made black gold rush in Iraq lose its sheen for the likes of Exxon Mobil, Royal Dutch Shell and BP?

The lack of political stability, security issues, contractual uncertainties and infrastructural bottlenecks in Iraq is keeping the latter at bay. Oil still remains the property of Iraq state. All that foreign companies are getting here is a fixed price per barrel while Iraq government keeps the major gains. No wonder Western firms are unwilling to commit. However, all these constraints are of little concern to state oil companies especially in China. The latter are more concerned with access to Iraq's oil resources than making huge profits. This is working in Iraq's favor. It is still getting investments and help to develop the energy sector without losing control over its oil assets. Nonetheless, the approach has limited Iraq's production potential.

Whether this approach of Iraq works in its favor or not is something time will tell. But there is one very important lesson for our Government to learn. It is not just enough to be asset rich. As India aims to ride the growth wave through foreign investment, it needs to take care of investment climate and put right policies in place. Else the potential will remain untapped.

In an attempt to gather momentum and advocate entrepreneurism in the area of information technology products, industry lobby Nasscom has partnered with global IT majors Google and Microsoft to launch a programme. The former is reportedly looking at investing a sum of US$ 10 m towards the same. Essentially, this initiative would create a start-up ecosystem for new companies (estimated at 10,000) to test, build and market products. This definitely is a positive initiative. This we say because entrepreneurs would be able to receive funding and support to start up their organizations. But at the end of the day, companies like Google and Microsoft are not charitable organizations. And there would tend to be an agenda behind this initiative. We believe such initiatives should be taken up by the government as well. Here finances could be provided to credible start-ups and allow them to maintain their independence.

The slowdown in the auto industry has been bothering the Indian auto sector for quite some time now. And now they have the added burden of having to deal with possible wage hikes. Indeed, the time taken for wage negotiations with workers has been quite prolonged. The possibility of an early wage settlement seems increasingly unlikely. Further, the incidence of agitations and labour strikes has also risen in recent times as workers have demanded better salaries and benefits. Auto companies typically revise the wage settlement once every three years. However, of late, the time taken to negotiate wage settlements has been getting unusually long. As a result, strikes by workers have been crippling production with unfailing regularity. This has naturally impacted the profitability of companies. The violence and lockout at Maruti's plant at Manesar last year is a classic case in point. And recently players such as Hero Motocorp, Bosch Ltd and M&M are facing problems on this front too. Obviously, most of the managements will not concede to all demands made by workers. There will be efforts to reach a compromise. However, for the overall industry, rise in wage costs is a trend that most auto companies will have to keep in mind going forward.

Profit booking in commodity, power and auto stocks have kept the benchmark indices in the red throughout the session today. Backed by weak cues across Asian stock markets, the key indices in Indian equity markets opened lower and languished in the red. The BSE Sensex was trading lower by around 87 points at the time of writing. Other major Asian markets closed lower while markets in Europe opened flat to positive.

 Today's investing mantra
"Absent a lot of surprises, stocks are relatively predictable over twenty years. As to whether they're going to be higher or lower in two to three years, you might as well flip a coin to decide." - Peter Lynch

  • Lessons from Peter Lynch

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