Modi Government Must Stop Half Measures on IL&FS

Video Editor: Mohd Ibrahim and Purnendu Pritam
Video Producer: Anubhav Mishra

Towards the end of September 2018, I had alerted PM Modi and FM Jaitley about the sheer folly of dithering over the IL&FS crisis. I had written The Fable of Two Faxes for them.

Within 72 hours, the government acted superseding IL&FS’s complicit board appointing private sector titans like Uday Kotak and Vineet Nayyar among others. But alas, it was a half measure since it took lessons from only one fable; the one about Satyam.

The Fable of Satyam Fax

Satyam Computer Services Limited was a multi-billion-dollar company spanning 67 countries and six continents. On 7 January 2009, its founder, Ramalinga Raju, faxed a shocking confession to the stock exchanges. The fax read:

The balance sheet carries as of September 30, 2008 inflated (non-existent) cash and bank balances of over $1 billion. The gap in the balance sheet has arisen purely on account of inflated profits over a period of last several years. I am now prepared to subject myself to the laws of the land and face the consequences thereof.

All hell broke loose. The Satyam stock tanked 78 percent and Indian markets fell over 7 percent, before the stock was swiftly removed from the Sensex.

The broking firm CLSA called it India’s Enron, an accounting fraud beyond imagination and an embarrassing and shocking episode in Indian corporate governance.

But acting quickly, India’s Company Law Board used its exigent powers to sack the entire board.

Manmohan Government to the Rescue

The Manmohan Singh government appointed a couple of private sector professionals with unimpeachable integrity and global credibility. It issued a statement that read:

The credibility of India’s IT sector should not be allowed to suffer.

In just three months, Satyam was sold to a joint venture of British Telecom and India’s Mahindra Group at Rs 58 per share. The Satyam stock more than doubled after it was re-christened Mahindra Satyam. On that day, the government learnt a critical lesson — to not fiddle when Rome is burning.

But is IL&FS Crisis Same as Satyam?

But the IL&FS crisis is across India’s financial economy. Much more systemically lethal than a founder’s fraud at one company. Right or wrong, IL&FS is seen to be a quasi-sovereign entity, owned and controlled by a clutch of public sector giants, including SBI and LIC.

So this is not the time to argue about nuances around moral hazard. A $ 3-trillion-economy should not be held to ransom for a few billion dollars of liabilities.

Allow me to reiterate.

The Fable of UTI Tax

This fax popped up in Lutyens Delhi on the evening of Saturday, 30 June 2001. It was an SOS about Unit Trust of India (UTI), a public sector mutual fund set up by an Act of Parliament in 1963, which then controlled an astonishing 8 percent of market capitalisation.

UTI’s flagship scheme, US-64, had gone bust, its net asset value (NAV) severely eroded with negative reserves.

Of late, UTI’s fund managers had been colluding with rogue bull-operator, Ketan Parekh, who was later convicted for a massive stock scam.

For example, US-64 was holding over 1 crore shares of HFCL which had dropped from Rs 2553 to Rs 79. It had a huge stake in Sriven Multitech whose price had crashed from Rs 450 to Rs 8.15.

But small unit-holders were clueless believing their investments were safe in the hands of the sovereign.

Jaswant Singh to The Rescue

On Monday morning, when US-64 investors learnt that their life’s savings had vanished, all hell broke loose. For nearly one year, Finance Minister Yashwant Sinha was caught in the cross-fire, unable to make up his mind whether to bail out US-64, or let it go belly up.

Finally, he was replaced by Jaswant Singh, who put the might of the government behind UTI sanctioning a bailout package of Rs 14,561 crore. This calmed the markets. Eventually, UTI was privatised.

What Do the Satyam & UTI Crisis Teach Us?

So coming back to the IL&FS saga, let me reiterate that just the lessons from Satyam, ie superseding the board are not enough. If the defaults don’t stop, the contagion will be devastating, irrespective of installing a new board.

Already the markets have wiped out over Rs 10 lakh crore of investors’ wealth. Even now, the credit economy could gum up completely.

Remember, beleaguered public sector banks are staring at a direct exposure of Rs 40,000 crore in term debt given to IL&FS. Provident & pension/insurance funds have an additional Rs 30,000 crore at risk. NBFCs, mutual funds and others could be forced to write off the balance Rs 20,000 crore.

So equally critical are the lessons from UTI that is, the government should have

– in fact, MUST – commit that it shall – I repeat, shall – backstop the Rs 34,000 crore that ILFS has to pay from now until 31 March 2019.

It has a plethora of options to do that.

Just one example could be a superior debt/equity instrument issued to National Infrastructure & Investment Fund (NIFF) to be repaid first, before other creditors and investors once an order is restored.

And after that, the regulators can begin the arduous process of systemically reforming and holding accountable, everybody who messed up in this saga, from the founders, directors, ratings agencies the fragile apparatus of using short-term finance to fund long-gestation infrastructure projects, whatever!

Ironically, Prime Minister Modi needs to take lessons from the swift, decisive actions of two politicians he holds in disdain. Such, are the ironies of history.