Structure of the Indian debt market

Of the total INR88 trillion domestic debt outstanding in the capital market, sovereign debt accounts for INR64 trillion, while corporate debt accounts for the remaining INR24 trillion.India Inc.’s debt capital is primarily funded by bank loans (total bank loan to corporates is 2.8 times corporate bonds outstanding as on December 2015).The debt management and regulatory function of both public and corporate debt is done by RBI and SEBI.

Growth of bank credit and bad loans

After 1990, an array of financial sector reforms were undertaken, including deregulation of interest rates, licensing of new private banks, conversion of development financial institution into banks, and capital infusion by the Government. These reforms resulted in intensified competition, and the bank credit of all scheduled banks began to grow steadily, from less than INR2 trillion in FY95 to INR33 trillionin FY10, and more than doubled to INR73 trillion in FY16. The easy availability of bank credit, coupled with a robust equity market, has been powering the engine of economic growth for well over the past 25 years.

Also, gross non-performing assets (GNPAs) consistently fell for a decade and half after the financial reforms, from 15.3% in FY95 to 2.3% in FY09. However, the slowdown after the global financial crisis of 2008 had its impact on the Indian economy as well, resulting in asset quality distress. As a result, gross NPA started increasing, from 2.5% in FY10 to 4.4% in FY15. The global economic slowdown, coupled with domestic issues such as excessive leverage, overcapacity, policy logjam and other sectoral-specific issues only aggravated the situation. As corporates began defaulting on interest and repayments, including previously restructured ones, the stressed assets (GNPA + Restructured advances) of banks gradually ballooned to alarming levels, from 5.8% in FY11 to 11.5% in FY16.

While the stressed assets crisis should not have come as a surprise to the industry watchdogs, the sheer size and consistency of defaults caught the lenders and owners unprepared.

Management of bad loans

From the lenders’ point of view, bad loanscan either be recovered, sold, restructured or settled.

There are several recovery options, most common of which are enforcement of security and sale to asset reconstruction companies (ARCs),and recovery from Debt Recovery Tribunal (DRT) and LokAdalat.The recovery rate, however, has remain tepidat about 26%.

The size of bank loans is unsustainable at current levels of operations; therefore, distressed sale and revival of the borrowing company are the more preferred options for lenders, especially in case of large exposures.  Banks can either take control of the business to turn it around or sell the bad loans to ARCs and focus on its core operations.However, ARCs are still not a preferred resolution framework because of market challenges such as valuation expectations between ARCs and seller banks, inter-creditor consensus and the absence of a secondary market for SRs.

Restructuring of loans also has multiple manifestations.

• The Corporate Debt Restructuring(CDR)mechanism was introduced in 2001for restructuring of the corporate debts of viable entities facing problems, outside the purview of BIFR, DRT and other legal proceedings, for the benefit of all concerned. However, CDR cellhas witnessed more failed exits than successful ones.
• RBI has regularly introduced newer schemes to strengthen debt resolution.
• The Joint lender forum (JLF) mechanism was introduced in April 2014 to facilitate the recognition of early warning and resolutions by mandating the formation of a JLF once the account is reported as SMA-2 and the proposal of a corrective action plan.
• The 5/25 scheme was introduced in July 2014 to address the mismatch between the long gestation periods of projects in infrastructure and core industries sectors and the repayment tenure of loans.
• Under the Strategic Debt Restructuring scheme introduced in June 2015, lenders can acquire control of distressed companies and initiate a turnaround. It has so far not metthe desired success mainly due to mismatch of valuation expectations.
• The Scheme for Sustainable Structuring of Stressed Assets (S4A), introduced in June 2016,allows promoters to remain in control if more than 50% of their debt is “sustainable,” and the unsustainable portion is converted into an equity or quasi-equity instrument.

The otherpopular debt-management strategies used by corporates as standalone strategies or as part of the overall restructuring package include the sale of non-core assets,structured funding, externalization of domestic debt, debt transfer to subsidiaries, implementation of a turnaround plan ,issuance of bonds,and capitalization of interest pay-outs on loans against projects.

Conclusion

In order to arrest value erosion during the ongoing debt crisis, there is an urgent need to re-channelize debt into productive areas. The success of all efforts in crossing this low tide of debt cycle hinges on collaboration between lenders, promoters and regulators. Lenders may have to take “hair cuts,” promoters may have to let go of their controlling stake, and theinvestor community would have to rise up to the challenge to bring back to health the bleeding industries. The Government, it seems, is committed to make the necessary policy changes to protect economic interests of the country.