No bailout for IL&FS?

It’s hard to miss the message in the failed rights issue of Rs 45 billion of Infrastructure Leasing and Financial Services (IL&FS) that closed last week. The rights issue and liquidity support of around Rs 35 billion from Life Insurance Corporation (LIC) and State Bank of India (SBI) were key to any revival plan for the beleaguered company. With the public shareholders not subscribing to the rights issue, the prospects of a bailout appear to be fading.
 

The decision to not subscribe makes sense. What shareholder would want more exposure to a company whose very solvency is in doubt? Moreover, the amount of Rs 80 billion may have sufficed before the parent company was downgraded to “default”. After the default rating, the bailout amount required is estimated at upwards of Rs 250 billion. SBI has non-government shareholders. LIC is accountable to policyholders. Neither would have an appetite for the larger bailout amount.

A bailout can thus come only from the government. Leaving aside the sum involved, a government bailout of a private company would be a huge risk in the run-up to the general election in 2019. It does look as though IL&FS is headed for liquidation under the auspices of the National Company Law Tribunal (NCLT). The sell-off of financial stocks in recent days suggests that the markets have latched on to the distinct possibility that a bailout won’t happen. 

The government’s principal concerns now would be to avert too steep a drop in the stock market in the short-run and a crisis in the non-banking financial companies (NBFC) sector. It may try to address the first by expediting settlement with the National Highways Authority of India (NHAI) on payments due to IL&FS and by facilitating a quick sale of some of IL&FS’ assets to NHAI. That would help IL&FS repay some of the commercial paper that’s maturing, relieve the redemption pressure on mutual funds and help contain the fall in stock prices. 

As for the NBFC sector, starting last month, the Reserve Bank of India (RBI) has announced several measures to improve liquidity in banks and hence the flow of funds to NBFCs. The latest was the decision last week to raise banks’ exposure limit for NBFCs from 10 to 15 per cent of capital. In addition, SBI has announced that it will buy loan assets up to Rs 450 billion from NBFCs. If these and other measures that may follow help contain systemic risk, the government can pat itself on its back for having called the ‘too-big-to-fail’ bluff for once.

The stronger NBFCs will be taken care of in terms of the availability of credit although they will face higher costs. Asset growth in NBFCs is bound to slow down. The realisation has dawned that NBFCs and financial markets cannot make up for bank lending, least of all for infrastructure. That is welcome news except that public sector banks remain moribund and cannot readily reclaim market share. Expect the credit crunch to worsen. Add to that the worsening global outlook and the current forecasts for India’s GDP growth — of 7.4-7.5per cent — look optimistic.  

Dark clouds over world economy

On the face of it, the world economy seems to be chugging along nicely. The International Monetary Fund’s World Economic Outlook (WEO) (October 2018) forecasts growth for 2018 and 2019 at 3.7 per cent, just 0.2 percentage points below the growth in 2017.

Look closely, however, and the signs are not just grim but ominous. The WEO lists several “downside risks” that have the potential to derail growth and even trigger another financial crisis — perhaps as early as in 2019. 

An obvious threat is rising protectionism. Should the US choose to escalate import tariffs as threatened, US GDP growth would fall by 0.9 percentage points and China’s by 1.6 per cent in 2019. Global GDP would fall by more than 0.8 percent in 2020. We are staring at a perfect storm.

A second major risk comes from tightening conditions in financial markets as interest rates in the US go up faster than expected. The danger is not just foreign capital exiting emerging markets and worsening current account deficits. Many emerging markets have built up forex war chests that can help them cope with pressure on their currencies.

The real danger is elsewhere — in the enormous build-up of public and private debt, thanks to a prolonged period of low interest rates. The IMF chief Christian Lagarde observed ahead of the Fund’s annual meet in Bali that total world debt — public and private — had risen by 60 per cent in the decade since the financial crisis. A sharp rise in interest rates has the potential to destabilise economies. 

A more fundamental point the WEO makes is worth underlining. It’s all very well to talk of the recovery in the global economy in the years following the crisis. But the growth that we have seen is a bouncing back from a fall in output in many economies. A decade after the crisis, output remains below the pre-crisis trend in 60 per cent of economies. 

Inequality has grown in the advanced economies. Trust in mainstream parties and institutions has eroded. There is less fiscal space today to deal with another crisis. In this toxic environment, the US administration has chosen to embark on policies that increase the probability of a crisis for the world economy. This is eerily reminiscent of Cold War brinkmanship.  

The writer is a professor at IIM Ahmedabad. 

ttr@iima.ac.in