IL&FS crisis: Road leading to dead end?

The current financial crisis at IL&FS is threatening to assume dimensions that could impact the whole domestic financial system. However, it may be worthwhile to think of this as not the malaise, but only a symptom. The malaise is more deeprooted and goes back a long way.

The first is the operational structure of Infrastructure Leasing & Finance Services (IL&FS), which is interesting at the best and somewhat unnerving at the worst. Every IL&FS project comes under separate project entities, either subsidiaries, joint ventures (50:50) or associate ventures. The balance sheet of IL&FS in FY2018 showed 24 direct subsidiaries, 135 indirect subsidiaries, six joint ventures (50:50 equity ownership) and four associate ventures (varying degrees of equity ownership). Also, typically the senior management at project level has more of an IAS-background rather than a techno-economic background, and often there is a record of government service. It is a pattern lending itself more to efficient liaison rather than efficient infra project execution.

Now, we talk of a coincidence which may or may not be so. The first element is that, under the NDA government, infrastructure projects have been given an undeniable push, but the project pipeline of IL&FS has unfortunately been on the decline. If the project award in the books of IL&FS would be carbon-dated, a good part of it would be linked to the Planning Commission-tenure of Montek Singh Ahluwalia. When Niti Aayog took over from the Planning Commission, the infra project awards – to the organisation founded exclusively to catalyse infra projects – have been meagre, to the point of being negligible.

The fact that the organisation operates through so many SPV entities would indicate that there are disparate partners in each. Ideally, with a single-minded focus, this would not be the case for the organisation. Then the theory turns – what if the partners are in reality of a political turn. It could be assumed that each (pre-digital India) cash-heavy project, would present a cash-cow to any entities that would want to helm the operations. The support of people who have experience of government corridors at the project management level does nothing to negate the assumptions.

In that context, one must now look at the continuity of rule across a decade (2004-14) of a political party and how post-2014, the power equations have changed with a new party which obviously does not aim to milk the same sources in the same ways. Certainly the behaviour of Niti Aayog, when taken in conjunction with more transparency in processes at many PSUs, like Coal India and Cotton Corporation of India, portents nothing positive for IL&FS in the manner of its hitherto functioning, particularly when the positives of such transparent functioning are there for all to see. So, as the wise man says, when too many compasses point north, one had better take heed.

In the context of lower orders, it could also be said that the SPV silo structure being promoted by IL&FS as a culture did not find favour with the Modi government, which is another cause for speculation that this structure was more for creation of conduits and dealings which were not strictly business-based.

It is also notable that IL&FS comes under the RBI purview only as a Systematically Important Non-Deposit Accepting Core Investment Company, a category where RBI created a framework in 2006 and modified it for more relevance in 2010. In terms of regulation, it is not clear how much scrutiny and reporting the RBI gets from IL&FS beyond the onetime process of obtaining a certificate of registration.

It may be argued that unlike banks or NBFCs, if IL&FS does not go in for public deposits, then it should not have so much scrutiny, but the reality is that IL&FS is too important a player in the system not to have checks and balances. Especially so when IL&FS has subsidiaries which do raise money through commercial paper and such other instruments. How the company has escaped rigorous scrutiny is a matter which should now be investigated, because it has undoubtedly been a factor in the current sorry state of affairs. Lack of rigorous scrutiny may also have been a factor in the domestic credit rating agencies being less than efficient with their analysis and rating. It is curious that all credit rating agencies downgraded IL&FS related schemes once its defaults began. They should have detected this earlier. It is documented that, in 2009, IL&FS took over Maytas in the aftermath of the Satyam scam.

The logic was legally tenable, however the process was not as watertight. At that time, in simultaneous depositions before the Company Law Board and the Registrar of Companies, IL&FS made contradictory statements.

What gave out a funny smell was that previously the CLB had taken a decision not to allow IL&FS even a board seat on Maytas, on the logical and tenable grounds of conflict of interest – IL&FS was not only a significant shareholder and a creditor but also a competitor in Maytas’ main area of operations. Still, with all this, ultimately in less than a year from then, Maytas actually came under the IL&FS umbrella.

The acquisition incidentally, did not go through the open-offer route, despite IL&FS and other companies acting in concert having a shareholding in excess of 40 per cent, which would prima facie be against the Sebi regulations.

Clearly, IL&FS had the blueeyed boy status in many ways. In such cases, it is generally observed that firstly political factors have some role to play in the matter, and secondly the end is always a financial disaster.