Wrong diagnosis

Political servitude is what basically ails FIs

What is common between the famous, multi-billion-dollar Iridium project of Motorola, which boasted over 60 satellites in space, and the steel projects of the Ruias, Jindals and Mittals? Wrong assessments by lenders on business potential — on the face of it. While the Iridium project has gone down in the annals as the biggest writeoff in business history, the promoters of the steel projects are paving the way for financial institutions (FIs) to take over the projects. Money is lent to businesses on the basis of projections pertaining essentially to the cash inflow and outflow a company envisages. This forms the fundamental basis of project finance.

Businesses fail on account of a mismatch of these parameters — indicating wrong projections. That is a business risk that lending institutions take everywhere when lending to projects. To cover this risk, FIs take security and guarantees for their money. Promoters’ equity as collateral is one such, allowing FIs to take over the project in the event of a business plan failing. This is what has been done in the case of the steel projects. But can taking over a project be a solution for FIs? What are FIs to do with a steel project? They are not in the business of making steel. If they sell it, the buyers know that this is a distress sale. The unrecovered money from a poor sale then becomes a bad loan for the FI. If the loaned sum is large, it is in the FIs’ perverse interest to continue lending, to ensure that they do not become NPAs.

The problem of course is that FIs are not free to take their lending decisions on business considerations. Funds are lent on the basis of a variety of considerations, several of them non-economic. A company’s political influence and profile carry much higher weightage than the viability of its business plans. Weird projections are often overlooked and approved for investments if the business carries an impressive enough name plate. This is true of projects across the board, in steel, road, power, cement or petroleum. This is the biggest reason why lending institutions in India are sitting on a mountain of NPAs — not because their business acumen failed them but because their political masters did. In this environment, it is not even possible to ascertain how good these institutions’ business judgment is. Once political interference was removed, it would at least be possible to apportion responsibility where it was due.