Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.This is an entirely free service. No payments are to be made.
The menace of debt defaulters is a serious one. Firms which take on debt are obliged to repay. Most of them do so. But some of them default willingly. This causes a lot of stress for banks. Without a way to get rid of these stressed assets, they are reluctant to lend to deserving firms. This slows down economic growth.
The government and the RBI have taken several measures to deal with this issue. They have cracked the whip on wilful defaulters. Banks have been told to clean up their balance sheets. Banks have hived off many questionable assets to asset reconstruction firms. But the cleanup process will take some more time.
Recently the RBI has cleared the way for Foreign Portfolio Investors (FPIs) to invest in bonds that are in default. We believe this is an important reform. It will allow banks to sell off their stressed assets quickly. The buyers of such debt are usually foreign 'Vulture Funds'. The funds are constantly on the lookout for stressed assets globally.
These funds typically buy the bonds of a company in default and bring enormous pressure on the management to perform. Once a turnaround is complete, they exit by selling the bonds to more conservative investors. They usually make a good profit in the process.
It is important to note that foreigners are not prevented from buying such bonds, known as junk bonds. But during the recent Amtek Auto fiasco, they were unsure if they could buy the defaulting company's debt. The RBI's clarification will go a long way to clear up any confusion in this regard.
As per an article in the Business Standard, the global market for junk bonds is huge. In the US alone, the market size is around US$ 300 bn. Such a market does not exist in India but things should change post the decision of the RBI.
We believe this step will be a big help to banks which are struggling under their NPA burdens. The sooner they convert their stressed assets into bonds that can be sold; the better will be the prospect of the economic recovery.
For information on how to pick stocks that have the potential to deliver big returns, download our special report now!