India restores faith in capitalism
According to one of India's most respected bankers, it's a once-in-a-lifetime opportunity -- a mammoth sale of distressed assets, some $40 billion in the first round. Much could go wrong, of course, especially given that so many powerful interests have so much money at stake in the process. Fortunately, Prime Minister Narendra Modi's government, which has stumbled in some of its biggest policy moves recently, appears to be handling this particular challenge with both agility and a sense of urgency. That mindset should now be carried over into other parts of the reform agenda.
The fire sale of assets has been made possible by one of Modi's true achievements: the passage of a modern law to replace the creaking, ineffectual bankruptcy mechanism India had used earlier. The law gives courts the power to appoint resolution professionals to sell off and revive investments and companies financed by loans that have turned bad. The hope is that India's state-controlled banks will recover some of their money and that the economy-wide problem of stalled investment and stranded assets might finally begin to shrink. As has been made clear by the botched rollout of a nationwide goods-and-services tax, however, even a landmark reform can do great damage if not handled well. One problem with the new law has been apparent since the beginning: It didn't say anything about who could or couldn't bid for these distressed assets, leaving open the possibility that the same company owners who had bankrupted their firms -- many of them powerful and politically connected families -- could buy them back at pennies on the dollar.
This might seem counterintuitive. Someone who's deep in debt wouldn't seem likely to be the winning bidder at a blind auction. In India, however, company owners (or "promoters," in the local terminology) are adept at squirrelling away money -- whether company revenues or funds borrowed with the firm's assets as collateral -- using complicated group holdings and privately held corporations. At least some owners undoubtedly saw the new bankruptcy act as a way to retain control of the firms they had mismanaged, while avoiding the need to repay the loans that state-controlled banks had unthinkingly handed them.
At first, state banks seemed happy to oblige. Some senior bankers argued that the existing owners at least understood the sectors they were in and, if they offered high bids, banks should accept them in order to preserve the value of the assets as far as possible. In one much-publicized example, one of the banking system's largest debtors reportedly tied up with a Russian bank to bid for a steel company it had previously controlled.
This loophole threatened to discredit the whole process. Most observers have an understandably hard time understanding why owners who have demonstrated their inability to judge market conditions, or to abide by their promises, should be treated like any other bidder. Even if some of them had defaulted because of a shift in the economic climate rather than malfeasance or mismanagement, the damage done to the credibility of the process by including them in auctions outweighed any possible benefit.
So, it's welcome that the government last week issued an ordinance modifying the bankrupt- cy law so that anyone who runs a company into the ground is forbidden to bid for a distressed asset. (Parliament still needs to ratify the change within six months.) The government says that its "amendments aim to keep out such persons who have willfully defaulted, are associated with nonperforming assets, or are habitually non-compliant and, therefore, are likely to be a risk to successful resolution of insolvency of a company."
If nothing else, this means that, in the future, owners will be quicker to try and push their companies into resolution; the law allows them one year to raise funds that would allow them to retain control. That should help clear the credit pipes a bit faster. But there was always meant to be a larger purpose to bankruptcy reform as well: to revive a certain degree of faith in India's corporate sector, which had sullied its reputation over the past decade as high-profile promoters took out loans they knew they couldn't repay, defrauded investors and outright mismanaged their businesses. A bankruptcy process that ended with the same bunch of capitalists in control of the same sectors might have saved some banks -- and taxpayers -money in the short run. But it wouldn't have achieved the aim of restoring credibility, whether in state-controlled banks or in troubled infrastructure companies.
The new ordinance gives the investmentstarved Indian economy a chance to regain some dynamism and for investors to begin to trust the private sector again. India Inc. needs new blood and new faces.