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India's own Lehman moment

IL&FS had to be rescued by the Union government in liquidity crisis

Indias own Lehman moment

So close to the tenth anniversary of the collapse of the Lehman Brothers, India's own Lehman moment had arrived, almost. Infrastructure Leasing and Finance Services, better known as IL&FS to the wider public, had been teetering to a collapse because of its inability to honour its payments obligations with the Union government coming to its rescue.

A series of defaults by IL&FS group companies in August and September 2018 on term-deposits, short-term deposits, inter-corporate deposits, commercial paper, and non-convertible debentures, and rating downgrades in some and default on some other financial instruments massively affected the financial markets.

In turn, this caused redemption pressure on the mutual funds which held financial instruments issued by IL&FS and this had adversely impacted the sentiments on the stock markets, money markets, and debt markets. In a way, things were getting out of hand and it forced the government to intervene in the interest of maintaining financial stability.

The after-effects of the IL&FS fiasco closely mirror developments which had led to the much bigger global financial scam. Unchecked, the IL&FS collapse could have a similar adverse impact on the Indian financial system.

What was even worse was that while the company's fortunes were sinking and it was staring at possible collapse of the entire operations, the management had blithely gone on giving themselves hefty pay hikes and other benefits.

The ministry of corporate affairs moved to the National Company Law Tribunal, seeking removal of its existing board of directors. NCLT acceded to the government's plea on the ground that failure of the company would reverberate across the financial system and create a broader crisis.

It was a simple case of biting more than it could chew. Compared with its capital base, IL&FS had borrowed funds with glee and spent these on projects without bothering too much on their viability or the overall liquidity of the company.

As its large number of infrastructure projects failed to take off, the funds it borrowed became sticky and without adequate returns, IL&FS started failing to meet its obligations. Any failure to meet payments obligations meant that its erstwhile lenders developed cold feet in giving more funds. The company was thus facing a "liquidity crisis".

In its statement on taking over the board, the Union finance ministry has assured that it would ensure that the fund requirements of the company were completely met. The company has outstanding liabilities of Rs 1,15,000 crore and it was facing cash calls on repayment and other dues totalling Rs 91,000 crore. Against this huge liability, IL&FS was planning to raise fresh funds through issue of non-convertible debentures i.e., fresh loans. As the company was facing a situation in which their cash flows were negative, the banks had also stopped giving it fresh accommodation.

"The restoration of confidence on the money, debt, capital markets, banks and financial institutions, and in the credibility and financial solvency of the IL&FS group is of utmost importance for the financial stability of capital and financial markets," said the finance ministry in its statement.

There is an emergent need to immediately stop further financial defaults and also take measures to resolve defaulted dues to the claimants. This would require a combination of measures of asset sales, restructuring of some liabilities, and a fresh infusion of funds by the investors and lenders, according to the ministry.

The confidence of the financial market in the credibility of the IL&FS management and the company needs to be restored. There appears to be a significant liquidity gap in the company as estimated liabilities might not be covered by the assets or income flows.

The consolidated financial statement of the IL&FS holding company and its subsidiaries, associates, and joint ventures projected a highly exaggerated picture of its assets. The company's balance sheet claimed non-current assets in the form of intangible assets amounting to over Rs 20,000 crores.

However, the bulk of the revenue was in the form of receivables, around 50 per cent, which was locked up in litigation and arbitration. Added to this, there has been a sharp increase in bank deposits held in the lien, which rose by Rs 1,681.59 crores in 2017-18.

Overall, the company has negative cash flows from operations. Further, the net outflow was Rs 7,020 crores in 2017-18. From August 2018 the company has been making repeated defaults.

Financial experts noted there was a deep-rooted mismatch in the debt-equity ratio because of excessive leveraging, which has put a question mark in its ability to continue as a going concern if allowed to continue in the hands of the present management. The high debt stress was clearly visible in the company and its main subsidiaries for the past so many years, but was camouflaged.

(The views expressed are strictly personal)

Anjan Roy

Anjan Roy

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