Fears about the precarious position of the Indian economy are not simply limited to falling behind China in growth rates. Some of the country’s most important companies are facing serious troubles that reflect both their own management issues and also the state of the broader economy.
The key non-banking financial company, Infrastructure Leasing & Financial Services, went bust last year. India’s oldest private airline, Jet Airways, has crash-landed. When Anil Ambani’s Reliance Communication filed for bankruptcy in May, the businessman needed a last-gasp bailout from his elder brother, Mukesh Ambani, to avoid contempt of court and potentially jail time.
Then, on June 5, Dewan Housing Finance Corporation Ltd, better known as DHFL, has seen its commercial paper – short-term debt instruments – downgraded to “D”, meaning default. In other words, ratings agencies do not expect DHFL to be able to pay back the short-term debts it owes in full – including about Rs 850 crore of commercial paper.
What happened at DHFL?
DHFL is a non-banking financial company, also known as a shadow bank. This means it doesn’t have a banking licence or access to central bank liquidity, but is nevertheless involved in financial services – in this case, primarily giving loans to home buyers in India’s tier 2 and tier 3 cities.
In 2018, another major NBFC, IL&FS, went bust, causing alarm bells to ring throughout the industry. Banks became much more careful about lending money to NBFCs. But this led to a liquidity crunch, since there was limited access to credit. Many NBFCs rely on short-term borrowing to finance long-term lending, which puts them in a difficult spot when there is a liquidity crunch.
In September 2018, after the IL&FS crisis emerged, DHFL’s stock also took a hammering, by as much as 60%. Then, in January, Cobrapost claimed that the company’s promoters were involved in a Rs 31,000 crore scam to siphon off money. The company denied these claims and later said that an independent chartered accountant’s inquiry found them to be untrue.
Nevertheless, the combination of factors put DHFL in a difficult place, forcing the company to sell a number of its businesses to ensure it could pay back on debt. Regardless, on June 4, the company failed to pay about Rs 900 crore worth of interest, prompting ratings agencies to downgrade all of its commercial paper .
What does this mean?
The company insists that this is only a temporary problem and has said that it will pay back the amount within the seven-day grace period. If it is able to do so, this will allay some fears about this being an “insolvency issue” – whether the company itself can survive. Instead, it will become just a “liquidity issue”, suggesting the company just needs more time to mobilise money.
DHFL has insisted that the underlying assets that it holds, a big chunk of which are house loans, are valuable and have a very low non-performing asset percentage. But those underlying assets are worth about Rs 1 lakh crore. As a consequence, if this is indeed a solvency issue, if the company’s survival itself is uncertain, it could be a huge blow to India’s financial markets. This will lead to further panic – and tighter liquidity – across the system.
If the company fails, that will affect all of those that have extended credit to the company. That includes about Rs 50,000 crore from banks, another Rs 30,000 crore from the Life Insurance Corporation, pension funds and more. In other words, this isn’t about just one company failing: it is a danger to the already-beleaguered banking system.
What does it mean for mutual funds?
One sector has already been affected: mutual funds, which allow investors to put their money into a selection of stocks as picked by a fund manager. Indian regulations mean that once payments have missed their due date, ratings agencies have to move immediately to change the rating of the company, in this case move DHFL down to “D”. Subsequently, mutual fund companies have to immediately follow suit, and mark down all DHFL debt 75%.
That means that, if a mutual fund owns DHFL debt – even if it is not the bonds that the company was unable to pay in time – it has to be marked down 75%. UTI Mutual Fund, for example, which owns a large amount of DHFL paper has written down all of that debt completely, meaning it doesn’t expect to get anything back.
This may change if DHFL does indeed manage to pay the money back by Monday as promised. But regulations mean ratings agencies cannot immediately change the company’s grade. As a result, mutual funds and their clients will have to be prepared to not earn that money back and also to guard against speculative investors hoping to make a quick buck.
What about the broader economy?
India’s economy currently faces severe challenges, both domestic and international. In better times, with more money generally in the market, a number of these companies like Jet and DHFL may have found it easier to dig their way out of hole.
But with India’s growth story in danger and a steep drop in consumption, the failure of DHFL could have major repercussions across the economy, which is already struggling to deal with the twin-balance sheet crisis – a high number of non-performing assets and heavily indebted corporates.
A proper default would lead to an even tighter liquidity crunch, further fears about the viability of NBFCs, and a knock-on effect on numerous other industries. It will also command greater regulatory attention, at a time when India’s policy makers and regulators need to be thinking about steadying the ship. Andy Mukherjee of Bloomberg has even suggested that this is the time for a mega bailout, or else things will only get worse.