The great Indian debt time bomb

Nov 24, 2014

- By Vivek Kaul

Vivek Kaul
On November 17, 2014, Adani Enterprises put out a statement saying: "Adani Mining, the Australian subsidiary of Adani Enterprises, and the State Bank of India (SBI), the country's largest lender, have today signed an MOU in the aftermath of the successful Brisbane G20 Summit...

The MOU provides for a credit facility of up to $1 billion USD subject to the detailed assessment of the company's mine project at Carmichael, near Clermont in Western Queensland."

This MOU was questioned in the media. The basic question asked was: Should Adani Enterprises, a company already having a lot of debt, be allowed to raise more debt? Further, the environmental concerns around the mine were highlighted as well.

As on September 30, 2014, the total debt of the company stood at Rs 72,632.37 crore. It had shot up by Rs 7653.33 crore from where it was on March 31, 2014.

The total operating profit of the company over the last four quarters was at Rs 8,999.92 crore. The interest that it paid on its debt was Rs 5,733.77 crore. This means an interest coverage ratio of around 1.57.

Interest coverage ratio is essentially the earnings before interest, taxes and exceptional items (or operating profit) of a company divided by its interest expense. It tells us whether the company is making enough money to pay the interest on its outstanding debt.

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If we look quarterly data, the situation becomes more interesting. The interest coverage ratio of the company was 2.67, for the period of three months ending March 31, 2014. It fell to 1.58 as on June 30, 2014. And for the period of three months ending September 30, 2014,it stood at 1.12.

An interest coverage ratio of close to one basically tells us that the company is making just about enough money to keep paying interest on the debt that it has. Clearly, a worrying situation. Ideally, the interest coverage ratio of a company should be over 1.5.

What this tells us is that Adani Enterprises isn't in the best financial shape. After some criticism in the media, Arundhati Bhattacharya, the chairman of SBI, said that the loan will go through "proper due diligence both on the credit side as well as on the viability side." She also said that the board of SBI had yet to take a call on the loan. "The board will take a call and then only the loan will be sanctioned," Bhattacharya said.

Bhattacharya further clarified that a new loan to Adani Enterprises will be given only after the company had repaid portions of the earlier loan given to them by SBI. After that had happened, the fresh lending to the company would work out to only $200-400 million.

As far as environmental concerns went, Bhattacharya said that she had been assured by the Queensland government (where the Carmichael mine is located) that there were no environmental issues around the project.

News-reports appearing in the media clearly suggest otherwise. There seem to be environmental concerns around the mine, as the project is adjacent to the Great Barrier Reef. A recent news-report in the British newspaper The Guardian said that the Rainforest Action Network, a US environment group, had written commitments from US banking giants Citigroup,Goldman Sachs, and JPMorgan Chase, to not back the project.

Before this several British banks had also ruled out funding the project. The news-report pointed out that "several avenues of finance have already been shut off to the $16.5bn project. Deutsche Bank, Royal Bank of Scotland, HSBC and Barclays all ruled out funding the development, before the US banks' refusal."

Another recent report in The Guardian points out "construction of Australia's largest ever mine[i.e. the Carmichael mine] will be well underway before its impact upon the environment is known, with a requirement to replace critically endangered habitat razed by the project pushed back by two full years."

So, clearly there are environment concerns around the mine, irrespective of what Bhattacharya has been told by the Queensland government. Nevertheless, it was nice to see Bhattacharya come out in the open and clarify that SBI would go through proper due diligence before deciding to give Adani another loan.

If other public sector banks had done that in the past, they would not be in a mess that they currently are in. In August 2014, the finance minister Arun Jaitley had told the Parliament that bad loans in the banking system had risen to 4.03% of the advances in 2013-14. The number had stood at 3.42% in 2012-13 and 2.94% in 2011-12.

In fact, the situation is much worse for public sector banks. As on March 31, 2013, the gross non performing assets (NPAs) of public sector banks had stood at 3.63% of the gross advances. By September 30, 2014, this had jumped up to 4.80% of the gross advances. During the same period the gross NPAs of private sector banks has been more or less stable at 1.8% of gross advances.

This is something that the Reserve Bank of India points out in the Financial Stability Report released towards the end of June 2014, as well. The stressed advances of the Indian banking system stood at 9.8% of the total advances. For public sector banks the number stood at 11.7%.

What this means in simple English is that for every Rs 100 given by Indian banks as a loan nearly Rs 9.8 is in shaky territory (for public sector banks the number is at Rs 11.7) The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank).

The report further points out that "There are five sub-sectors: infrastructure (which includes power generation, telecommunications, roads, ports, airports, railways [other than Indian Railways] and other infrastructure), iron and steel, textiles, mining (including coal) and aviation services which contribute significantly to the level of stressed advances."

These sectors (especially the infrastructure sector) are dominated by crony capitalists, who were able to get loans from public sector banks, and are now unable to repay them.

An excellent example here is that of Lanco Infratech. As on March 31, 2014, the company had total loans amounting to Rs 34,877 crore. Against this the company had a shareholders' equity of Rs 1,457 crore. This means the company had a debt to equity ratio of around 24. Not surprisingly for the period of three months ending September 30, 2014, the company had an operating profit of Rs 317.23 crore and finance costs of Rs 773.02 crore.

What this clearly tells us is that the banks giving loans to this company did not do any due diligence or were simply under pressure to hand out loans. This is not surprising given that its founding Chairman L Rajagopal was a member of parliament from Vijaywada on a Congress Party ticket, in the last Lok Sabha.

There are many other companies run by crony capitalists which are in a similar situation and are unable to repay the loans they had taken on. This has led to trouble for banks, particularly the public sector banks.

Uday Kotak, Executive Vice Chairman and Managing Director of Kotak Mahindra Bank, in a television interview earlier this year had estimated that the Indian banking system may have to write off loans worth Rs 3.5-4 lakh crore over the next few years. When one takes into account the fact that the total networth of the Indian banking system is around Rs 8 lakh crore, one realizes that the situation is really precarious.

To conclude, it is worth recounting here what the economist John Maynard Keynes once said "If you owe your bank a hundred pounds, you have a problem. But if you owe your bank a million pounds, it has."

The modern day version of this quote was put forward by the Economist magazine when it said "If you owe your bank a billion pounds everybody has a problem."

The point being that any bank has to be very careful when giving out a large loan. Indian public sector banks seem to have forgotten that over the last few years. And now we have a problem.

How should the public sector banks handle the current NPA mess that they have landed themselves in? Post your comments or share your views in the Equitymaster Club.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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5 Responses to "The great Indian debt time bomb"


Nov 27, 2014

The basic reason is window dressing of financial statements which the auditor does. The auditing person should be made accountable for non transparency in reporting. The auditing community should be declared as public servant. The banks fail a analyse the financial statement without any bias under pressure from Politicians/ Bureaucrats. There is a need separate lokadalats for bank cases. The judgement of lokadalat should be appealed against in High Court alone. The promoters personal assets should be attached and seized



Nov 26, 2014

The only way to deal with defaults and NPA's of this magnitude is to wield a big stick. Pick any one major and chronic defaulter from every bank and freeze their accounts completely. Let the company collapse and let the employees and creditors suffer. They will exert enough legal, societal and personal pressure on the managements to come to the table and settle. If they do not, bad luck for the sufferers. The rest of the defaulter community will get the message and fall in line quickly. Naturally, each bank will have to provide for a cushion to absorb sudden and large possible write-offs. The media also will have to stop lionising these shameless operators.



Nov 24, 2014

Western banks generally work in cahoots with western companies. The croniism in West in less visible. For strategic projects it is up to Indian banks to finance Indian companies, just like China does. PSU Banks in India are vulnerable for political pressure and hence the high NPAs. I am all for privatisation of PSU banks. But we have to make sure that Govt provides no deposit insurance or guarantee to any bank deposits. If any bank fails, it will be allowed to fail without any tax payer rescue. And promoters/management of the bank will be liable for bank failure to the tune of 50% of their personal net worth. That should keep thingn clean. None of this will ever happen anyway. We are in a socialistic society and banking system is the thief itself. Perpetual Credit growth without occasional debt write off is impossible and is part of the design of the present system.


AB Pereira

Nov 24, 2014

Since most public sector banks have lent based on instructions from above, the situation is on expected lines. Cronies support the parties to come to power, and duly get their share of benefits. Mallya's Kingfisher was one more example to that of Lanco, Adani etc. The reason for nationalising the banks was for social welfare, but it has been turned into crony-welfare by the successive governments at the Centre.
The approx 4% NPAs is only a tip of the iceberg. Deep down in their loan portfolios, there are huge dynamite-exposures that can explode anytime (like Lanco, which dont even have interest cover of 1, then where is the Debt Service Cover?), especially when the deferral of recognition of impairment on technical grounds, stops.

Who contributes to the losses? The common man of course! Yes indeed, since the government pumps taxpayers money (or prints money that creates/increases inflation) by way of equity into these white elephants to keep its majority stake and to keep them alive to serve more cronies in future!



Nov 24, 2014

on Adani-Queensland government deal, comments from other banks / newspaper may be motivated and need to be studied. Also the Queensland government OK implies that environment clearance is available else it is for Adani to build safety provisions in its contract.

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