|»5 Minute Wrap Up by Equitymaster|
On This Day - 18 MARCH 2013
Is lack of bankruptcy law hurting India?
In this issue:
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.
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.
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.
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.
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