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Recently the RBI governor Raghuram Rajan warned corporate India against taking on too much debt. The problem is indeed serious. Many corporate houses got into trouble during the last few years. They blamed the economic slowdown for their woes. In reality, the root cause of their problems was debt or rather too much of it.
We have no problems with companies borrowing to grow their operations. But our concerns stem from their ability to repay. Indeed this is the Achilles heel of the Indian economy. So many companies are struggling to repay loans that the NPA menace in the banking system has reached historic proportions. Even re-structuring such loans has not helped. That's because it's not a problem of liquidity. We believe it's a problem of solvency.
The US junk bond market is a classic example. Most of the US shale gas firms funded their operations with high-yield debt i.e. junk bonds. This meant their business model was viable only if the price of crude was very high (above US$ 60). A price of crude of US$ 35 renders them unviable. Some of these companies are highly likely to default. The US junk bond market is already flashing warning signs.
This brings us to Indian firms. Are they in trouble too? As per an article in Livemint, yields on bonds issued by JSW Steel and Vedanta spiked recently. This does not mean they are in immediate trouble. However, it is bound to make foreign investors jittery. This is even more of a problem if the rupee were to depreciate further against the US$.
Considering that Indian firms have borrowed over US$ 22 bn overseas so far this financial year, we believe the solvency risk cannot be ignored. This is why we always recommend investors stay away from those stocks where the underlying business is debt ridden. When your hard earned money is at stake, the default risk is something investors should avoid at all times.
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