Context:
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A series of defaults by the IL&FS holding company and group outfits beginning in August have set off a market-wide contagion.
About IL&FS:
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Infrastructure Leasing & Financial Services Ltd. (IL&FS) was set up in 1987 to finance and promote infrastructure projects in the country.
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This holding company is now a financial behemoth with assets of over Rs. 1,15,000 crore and a debt of Rs. 91,000 crore.
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IL&FS is a holding company that operates through 169 other companies.
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These 169 other companies are either subsidiaries, group companies or joint ventures with others. It has been in the past and is currently as well, associated with landmark projects.
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A few among these projects include the tunnel under the Zoji La Pass, Delhi-Noida toll bridge, Gujarat International Finance Tec-City (GIFT) and a host of road, power, water and port projects.
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Infrastructure Leasing & Financial Services Ltd. (IL&FS) is listed as “systemically important” by the Reserve Bank of India. Thus, it is too big to fail.
Defaults:
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IL&FS Finance, which is a group company of the holding IL&FS company, defaulted in late August on a commercial paper repayment. This development was followed by a default by IL&FS on repayment of a Rs. 1,000 crore deposit to Small Industries Development Bank of India (SIDBI).
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Pursuant to this, a series of defaults by the holding company and group outfits followed. These defaults ran into the weeks leading up to the annual general meeting of IL&FS on September 29.
How did this crisis take place?
Company borrowed many times its equity. This figure is rumoured to be between 10-18 times its equity. This money was borrowed to fund its infrastructure projects, most of which bring in returns over 20-25 years.
To compound matters, IL&FS’s borrowings were all repayable in the short to medium-term of roughly 8-10 years.
The chokepoint for IL&FS came from the fact that its projects were stalling and not being completed due to various reasons. These reasons ranged from:
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statutory approvals not coming in
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problems of land acquisition and
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projects simply becoming unviable as it happened in the case of power plants.
Further, with returns from these projects not coming in, IL&FS was forced to borrow more. Lenders pulled the plug leading to trouble for IL&FS.
It is important to note that assets and receivables were exaggerated in the financial statements and the top managers took home large pay-outs and continued to pay dividends to shareholders despite the financial situation. An investigation has been ordered by the Serious Fraud Investigation Office.
How government responded?
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Recently, the Centre moved to supersede the Board of Directors.
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The decision to change the management has ushered in the appointment of experienced people. It is believed that these appointments should lend confidence to lenders and investors.
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The Centre has explicitly stated its intent, which is to “ensure that needed liquidity is arranged for IL&FS from the financial system”.
Concluding Remarks:
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In conclusion, there are some important questions that need to be answered.
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If IL&FS was a systemically important company, how did its over-leveraging escape the notice of the Reserve Bank of India?
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What did the periodic inspections of the company by RBI reveal? How did the developing situation pass the attention of shareholders? Did they look the other way since their dividends were serviced?
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Finding answers to these questions is as important as rescuing IL&FS.
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Finally, it is felt that there is a need for long-term finance sources for infrastructure projects.
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Currently, the LIC and some insurance companies are the only domestic sources and they too do not lend beyond 10 to 12 years.
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Thus, the Centre and the RBI should look at ways to deepen the debt markets where infrastructure players can borrow long-term.
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Moreover, it also needs to be analysed as to how a company listed as “systemically important” managed to fly under the radar with misgovernance. It is important to note that the debt pile-up due to over-leveraging did not happen overnight.