India Is No Longer A Defaulters Paradise

When Mukesh Ambani, India’s richest man, hosted a lavish, three-day wedding for his eldest son, the guest list was naturally a who’s who of the corporate community. But as the couple celebrated their new future, some of those business leaders were likely fretting about theirs.

Among the attendees were a number of tycoons fighting to keep control of their companies as creditors demand to be paid and regulators get tough on owners. These included steel magnate Sashi Ruia and Mukesh’s own brother, Anil, whose telecom company has been on the ropes for years.

At the gala in Mumbai, they rubbed shoulders with other business leaders who see the country’s newfound rigor regarding bankruptcy as an opportunity.

India only made it possible to force bankruptcy proceedings a few years ago. Now, the world’s fastest-growing major economy has entered a brave new era in which owners must live up to the global norm of capitalism — pay your debts or lose your company.

Anil Ambani is a particularly striking example of how India is no longer a haven for defaulters. His mobile network operator, Reliance Communications, was in effect forced out of the market in late 2017 after elder brother Mukesh, who is chairman of Reliance Industries, launched Reliance Jio Infocomm the previous year.

Jio grew rapidly and is now India’s No. 3 mobile telecom operator, and its market share is growing at the expense of the top two players, Vodafone Idea and Bharti Airtel. As of the end of 2018, Jio accounted for 23.8% of the total market of 1.18 billion mobile subscribers.

RCom, as Reliance Communications is known, has been buckling under mounting debt since early 2017. After repeated defaults on bank loans and operational dues — and failed court tactics to avoid entering a formal bankruptcy resolution process — the company finally announced in early February that it will pursue an insolvency resolution at the National Company Law Tribunal.

The NCLT is the country’s bankruptcy court system and was set up under the 2016 Insolvency and Bankruptcy Code — India’s first-ever effective bankruptcy law.

Signaling a harsher stance on defaulters, Anil even faced the threat of jail time over his company’s debts. The Supreme Court ordered RCom to pay Swedish telecom equipment maker Ericsson 5.5 billion rupees ($79.89 million) before March 20, and said Anil would be jailed if the payment was missed. At the last minute, his brother Mukesh provided the necessary funds. Anil paid in full on Monday and avoided imprisonment.

Local media estimate that RCom owes about 460 billion rupees to more than 30 creditors. Those creditors, including HSBC, Standard Chartered, China Development Bank and State Bank of India, will try to maximize recovery of their nonperforming loans to RCom in the NCLT courtroom.

The stock market already seems to be factoring in the possibility that the insolvency proceedings will push RCom’s equity value down to nearly nothing. The company’s stock price opened this year at 14.58 rupees and closed at 4.4 rupees on Tuesday, compared to its all-time high of 844 rupees in 2008. The company’s market capitalization at the March 19 close was about 12 billion rupees.

The Ambanis were not the only business rivals at the wedding.

Sashi Ruia, co-founder and chairman of Essar Group, and Lakshmi Mittal were also there. Essar Steel has been in a formal insolvency resolution process at the NCLT since June 2017, soon after the Reserve Bank of India, the country’s central bank, listed it among 12 of the most-damaging defaulters and directed creditor banks to initiate the insolvency proceedings.

Mittal, meanwhile, is chairman of ArcelorMittal, the world’s largest steelmaker, which is hoping to take advantage of Essar’s bankruptcy process.

ArcelorMittal, in a partnership with Nippon Steel & Sumitomo Metal, won an NCLT-supervised auction for Essar Steel, and a committee of creditors approved Mittal’s 420 billion rupee bid in October 2018. Then Essar Group, controlled by the Ruia family, countered with a much higher out-of-court offer of 543.89 billion rupees, which would essentially cover all of the steelmaker’s payments.

Aware that Essar Group as a whole has a total overdue debt of 1.4 trillion rupees, however, both Essar Steel’s creditors and the bankruptcy court have dismissed the validity of the counter bid. The appellate court of the bankruptcy court system has told Essar Group to clear all of its debt if it wants its counteroffer to be seriously considered. The appellate court then directed ArcelorMittal on Monday to deposit the 420 billion rupees with creditors in a step toward completing the acquisition.

Although the Ruias may appeal to the Supreme Court, the probability that ownership of Essar Steel will shift to Mittal is rising day by day. This would give Mittal, who has been expanding his steel empire outside India, his first fully integrated steel mill in his home country.

A similar drama is unfolding at Jet Airways.

The same weekend as the wedding of Ambani junior, a Boeing 737 Max operated by Ethiopian Airlines crashed near Addis Ababa, killing all 157 on board. The accident prompted a wave of groundings of the U.S.-made aircraft by regulators in China, Europe, the U.S. and then India.

The move was initially seen as a further blow to troubled Jet Airways, which has five of the aircraft in its fleet. The airline announced on March 11, however, that the planes had all been grounded already due to its cash crunch.

Since August 2018, Jet Airways has missed payments of salaries for pilots and other employees, fuel bills, aircraft leases and bank loans, blaming higher oil prices and harsher price competition for its woes. At the end of September, the airline booked negative shareholders’ equity of 97.68 billion rupees.

As of Tuesday, only 41 of its 119-aircraft fleet were available for operation, with the remainder grounded by lessors due to the overdue payments. Even more aircraft may be grounded in the coming days as the company’s crisis deepens. India’s union of airline pilots sent a letter on Tuesday saying they will stop flying Jet Airways planes on April 1 unless the company give its pilots an assurance that salaries will be paid.

The country’s former No. 1 airline now appears to be on the verge of a complete shutdown.

Founder Naresh Goyal, who holds a 51% stake and serves as chairman of the airline, has been negotiating with creditor banks led by State Bank of India, largest minority shareholder Etihad Airways and potential new equity investors including Tata Group for a fresh capital infusion and financial and strategic restructuring. These efforts have so far been in vain.

Local media reports suggest creditors and other potential investors are all demanding Goyal’s exit as owner, chairman and board member over dissatisfaction with how the 69-year-old has run the airline.

Over the 16 financial years through March 2018, the airline posted net losses as many as nine times and an annual net profit of over 1 billion rupees only five times, despite the fact that it had become the country’s No. 1 airline in terms of domestic passengers in 2010. IndiGo overtook it in 2012.

The aggregate bottom line for those 16 years is a net loss of  56.37 billion rupees. For the nine months through December, Jet Airways posted a net loss of 32 billion rupees.

The situation became even more dire after stakeholder Etihad Airways said it will seek an exit from its investment in Jet Airways if its conditions for a bailout are not met. Prime Minister Narendra Modi’s government has reportedly held an emergency meeting with Jet Airways executives to find a way out of the crisis, but while the government is seeking a capital infusion to keep the airline out of formal NCLT insolvency procedures, Goyal’s position as owner chairman looks increasingly untenable.

“We are seeing what used to be unthinkable,” a veteran private-equity fund manager based in Mumbai said in March, commenting on the rising probability of corporate promoters losing their companies.

Until the current insolvency resolution regime was put in place, working hand in hand with stricter nonperforming loan recognition rules gradually introduced by the RBI from 2015, India lacked laws or regulations to forcefully put a defaulting company into the bankruptcy process.

According to Raghuram Rajan, former RBI governor and University of Chicago economics professor, the older system gave promoters “tremendous power over lenders.”

He described in a written testimony to the Indian parliament in September 2018 that those promoters used to be able to “refuse to pay unless [the] lender brought in more money, especially if the lender feared the loan becoming a nonperforming asset.”

Banks typically feared an increase in nonperforming assets on their books and thus would extend additional loans to their already defaulting borrowers to enable them to make overdue interest payments. He called the practice “ever-greening,” as these additional loans in effect kept the original loan “performing,” as long as the cover-up continued.

“Effectively, bank loans in such a system become equity, forcing banks to absorb losses in bad times, while promoters hold on” to their equity, Rajan said, pointing out that equity does not have a due date for repayment but that its value is erased in case of insolvency.

As of March 2018, 86% of the nonperforming assets in the Indian banking system were at state-owned banks, which are run by people appointed by the government. Critics say this opened the door to corruption if promoters were able to manipulate state-run banks via ties to politicians.

“It was a structure where mismanaged promoters utilized people’s deposit at state-owned banks as their bottomless purse,” said one senior business leader in Mumbai.

The new insolvency resolution regime, together with the RBI’s regulation on nonperforming assets, is dramatically raising creditors’ recovery rates.

India’s debt recovery rate stood at around 20% in 2015, compared with the OECD average of 72%, according to the World Bank. So far, out of concluded cases in the NCLT system, the aggregate recovery rates of financial and operational creditors are both 48%, according to the Insolvency and Bankruptcy Board of India, which oversees the entire resolution regime.

Of the total 1,484 insolvency petitions admitted by the NCLT system during the two years through December 2018, 302 cases ended up in liquidation and 79 reached resolution, in which most companies were sold as going concerns to new owners.

As Manish Sabharwal, a prominent economic critic and chairman of India’s largest staffing company TeamLease, put it, “It is no longer OK for promoters to overdue, or to overleverage.”―Nikkei Asian Review