It took just 24 hours for politics and optics to trump economics and common sense. On Thursday, I suggested that India was striking the right balance by preventing only “willful” defaulters from bidding for their own assets in bankruptcies. Since with most of the country’s $207 billion of impaired loans, there’s no proof of malfeasance by the controlling shareholders — or promoters as they’re known in India — they would be allowed to make an offer to creditors, just like buyout firms, vulture funds and other interested parties. Alas, a day later there’s an unpleasant twist in the tale. New Delhi chose to pass a stricter law, barring all promoters whose firms have run up nonperforming loans for a year or more (and who are unable to settle the overdue amounts) from repurchasing assets. In the 12 largest bankruptcies currently before the National Company Law Tribunal, involving $31 billion in creditor claims, the founders will have to sit out. The billionaire Ruia brothers can kiss their Essar Steel Ltd. goodbye. Unless the law is successfully challenged, they won’t be able to win back their steel plant. An appearance of being harsh on influential business families is politically a good thing for Prime Minister Narendra Modi, whose party faces a crucial election in his home state of Gujarat next month. But the economics of a broadside against crony capitalism are less than optimal.
Granted, promoters may have behaved badly in the past. They may be guilty of a callous disregard for the taxpayer who has had to bail out a rickety state-dominated banking system. The biggest lender, State Bank of India, has seen almost 10 percent of its loan book turn sour. For the five worst-hit state-run banks, nonperforming assets range between 18.5 percent and 25 percent. Yet what purpose will retribution serve? Knowing that promoters are out of the fray will only depress the value others are willing to bid. State Bank of India’s new CEO, Rajnish Kumar, says he doesn’t mind haircuts but doesn’t want to go bald. Well, he may have to now. Harsher haircuts will mean even bigger losses that need to be socialized. The burden on taxpayers will be higher, not lower.
Latest haircut fashion for Indian bankers: Bald
A better approach would have been to dismantle the two halfway houses created before the 2016 bankruptcy law kicked in. Scrapping the so-called Strategic Debt Restructuring (SDR) regime introduced by the central bank in 2015, and its variant, the Scheme for Sustainable Structuring of Stressed Assets (S4A), would leave debtors and creditors very little leeway to stall the inevitable. Rather than privately haggling over haircuts, let promoters present competitive bids for troubled companies in a formal bankruptcy process. That way, state-run banks will get the best possible value, and their owners — the taxpayers — will be wounded less badly than they are by the prevalent extend-and-pretend attitude.
But then, strengthening the bankruptcy law would take patient backroom work; it’s far easier to placate voters with, “Look, we’re taking the Ruias’ steel plant away.”