Why the IL&FS crisis is spooking debt and equity markets in India

What is the genesis of the crisis at IL&FS?

Focused on capital expenditure (capex) rich sectors, Infrastructure Leasing & Financial Services (IL&FS) has used the debt route to raise substantial capital in the past. The current problems started in August when IL&FS defaulted on Rs 4.5 billion worth of inter-corporate deposits (ICDs) to the Small Industries Development Bank of India (SIDBI). Over the next two weeks, the company also delayed payments on commercial papers issued by its subsidiaries. According to official data, the company has Rs 900 billion worth of consolidated debt. The company also has Rs 35 billion worth repayments scheduled for this year while it has less than Rs 2 billion worth of resources for the payment. 

Why is the IL&FS crisis a matter of concern?

IL&FS is a key player in the infrastructure space and is currently undertaking several government projects. The company is a systematically important non-deposit core investment company (CIC) as per the Reserve Bank of India’s (RBI) categorisation. Any crisis at IL&FS would not only impact equity and debt markets but could also stall several infrastructure projects of national importance.   

What is the role of credit rating agencies in the episode? 

IL&FS debt papers enjoyed highest safety status for a long time on account of factors such as satisfactory liquidity conditions and the backing of major public sector units. However, credit rating agencies (CRA), starting with ICRA, downgraded the debt instruments of IL&FS by eight notches in a matter of a few days. Some of its instruments are now ‘junk’ rated with several key institutions such as mutual funds, insurance companies and banks having substantial exposure to the company. Further, there are thousands of retail investors who either hold shares of IL&FS subsidiaries or own debt papers of the company through the mutual fund route. The sudden downgrade of IL&FS paper created panic in both equity and debt markets prompting investors to not just dump IL&FS papers, but also the equity and debt instruments of banks, non-banking financial institutions (NBFCs) and mutual funds that had an exposure to IL&FS. This is not the first instance where sudden downgrades by credit rating agencies have created panic among investors.  Earlier, a similar sell-off happened in Amtek Auto and JSPL.

Would a timely rating action have averted the crisis?

Swift action by CRAs would have certainly averted a full-blown crisis. However, there is a broader problem with the infrastructure sector in the country as several infrastructure projects are stuck either due to regulatory, environmental or economic reasons. Further, many IL&FS projects were awarded under the build, operate and transfer (BOT) model, wherein the firm builds the project and collects toll on it for a specified time period, after which the project is transferred under the government’s control. The problem is compounded by the fact that toll collections have fallen short of the projections in several of these projects impacting the company’s profitability. Hence, the downgrade of IL&FS debt was imminent.

A prompt response and action from the CRAs could have made things smoother.

What are the revival plans?

On Monday, the company approached National Company Law Tribunal (NCLT) seeking financial restructuring of its debt under Section 230 of Companies Act. If the NCLT admits the petition, the company can reorganise its financial structure along with that of its shareholders and creditors. Under Section 230 of the Companies Act, IL&FS and its lenders have immense room to bring out a multi-pronged plan while maintaining the existing equity rights of the company’s shareholders. It seems that IL&FS has chosen this route to cure its financial woes whereas if the company goes under the Insolvency and Bankruptcy Code (IBC), its present day management would not have any say on the outcome in the matter. This could provide relief to the company in terms of its current and near-term financial obligations. The company is also trying to raise fresh capital from its existing shareholders including LIC by issuing fresh non-convertible debentures worth Rs 40 billion. Further, it has approached the State Bank of India and LIC for a loan of Rs 35 billion, which have been approved by their respective boards.

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