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Rising Corporate Debt Signals at a Bigger Economic Problem

Mon, 22 May Pre-Open

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Recent NPA issues of Yes Bank and IDBI Bank signal a worrying trend. IDBI Bank reported its highest ever quarterly loss due to the continued bad loan slippages. On the other hand, Yes Bank had a wide divergence in its reported NPA numbers compared to the RBI audited numbers.

As more and more skeletons come out of the closet , it's important to identify the root cause of the problem. That of corporate debt. Apart from the banking sector, corporate debt has serious implications for the overall economy.

Banks with a sizable amount of bad loans on their books are reluctant to lend to even healthy companies. This will adversely impact the growth of the economy going forward.

Also, companies are forced to sell their assets once their debt levels become unsustainable. Moreover, it's not the bad assets of the company that go first. Since companies find it difficult to find buyers for their bad assets, it's the good assets that are sold first and that too at discounted valuations. These companies are now saddled with unproductive assets which further hamper their growth and ability to pay back debt. It leads to a downward spiral towards bankruptcy for such companies.

More than half of the corporate debt belongs to the Infrastructure, power, real estate, oil & gas and construction sectors. If borrowing to these sectors is contained, it will severely hamper India's economic growth.

We had mentioned in our previous edition of 5 Minute WrapUP on the risks of investing in companies with high debt:

• We believe that it is always a dicey affair to invest in companies with too much debt on their books. Indeed, the problem becomes all the more pronounced when there is a slowdown in the business because interest costs will still need to be paid and this exerts considerable pressure on profits. In severe cases, there have been companies which have had to entirely restructure, sell off assets so that the cash can be used to pay off debt.

My colleague Rohan Pinto through his ValuePro service ensures that he selects companies with a healthy balance sheet with little or negligible debt on their books. After all, debt is the single most important factor that can make or break a company's fortunes in the market.

For information on how to pick stocks that have the potential to deliver big returns, download our special report now!

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