For a deal of its size and implications, it has excited surprisingly little media attention: the $12.9 billion purchase of India’s Essar Oil by government-owned Rosneft of Russia proved to be a one-day media wonder in late August. There are reasons for this. First, it was a long time in the making. The deal goes back to the 2016 BRICS summit when it was signed in the presence of Indian Prime Minister Narendra Modi and Russian President Vladimir Putin.
But eclipsing the deal was a bigger issue facing Mumbai-based Essar Group: insolvency proceedings against Essar Steel. “Banks will not be in a position to provide cheap credit to the industry when they are saddled with a pile of bad loans on exposures to sectors like steel,” said State Bank of India (SBI) chairman Arundhati Bhattacharya at a conference in Mumbai. SBI is likely to get back part of its money from Essar, but is being forced to take a haircut.
The Reserve Bank of India (RBI) has started insolvency proceedings against Essar Steel under the new Insolvency and Bankruptcy Code — IBC. The Gujarat High Court has dismissed an Essar plea against the order. Criticism apart, the firm says it is attempting to correct the situation. “We have substantially deleveraged our portfolio companies’ balance sheets, reducing debt by over Rs. 70,000 crore ($11 billion @ $1 = Rs.64),” noted Essar director Prashant Ruia.
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Essar is part of a bigger problem which has hamstrung the entire banking system. Loan defaults are a way of life in India; even now the government has waived agricultural loans across the country. “Large NPAs (non-performing assets) are one of the biggest impediments in the effective operations of our banks and are eroding their profitability,” says Jayanta Nath Mukhopadhyaya, director of the Kolkata-based J.D. Birla Institute. “It is estimated that the bad loans of banks may be a staggering Rs. 10 lakh crore ($155 billion). This is significantly higher than the Rs. 2.5 lakh crore estimated in mid-September 2014. If we add the large stock of restructured loans, the figure goes up even more.” Notes a McKinsey report: “The stressed assets on the books of Indian banks are higher than the net worth of the entire sector.”
“Large NPAs are one of the biggest impediments in the effective operations of our banks and are eroding their profitability. Both banks and borrowing firms were resorting to different measures and ever-greening of bad loans.” –Jayanta Nath Mukhopadhyaya
Has the RBI Done Enough?
The RBI has delayed action until now. “Twelve accounts totaling about 25% of the current gross NPAs of the banking system would qualify for immediate reference under IBC,” notes an RBI statement. These companies account for most of the dud loans of domestic banks. A second list of another 12 companies has since been issued. (The NPA numbers don’t tally as estimates of bad loans differ, some putting the figure as high as Rs. 10 lakh crore, as noted above.)
“The old regime by which the creditor would get tired of chasing the debtor and end up recovering nothing is over now. If a debtor has to survive, he will have to service his debt. Or, he will have to make way for somebody else,” said Finance Minister Arun Jaitley at a chamber of commerce meeting in Delhi recently. “No promoter would like to cede control of his company,” says Mukhopadhyay. “I am therefore optimistic that the present steps will work.” It’s no surprise that defaulters like Bhushan Steel, Uttam Galva and Amtek Auto are falling in line.
Many see a system-wide ethics deficit as being the root cause of loan defaults. “This is one domain in which India could do with some positive progress,” says Jitendra V. Singh, emeritus professor of management at Wharton and fellow, Distinguished Careers Institute, Stanford University. “Distorted cultural norms arose during a period when business success was correlated with non-market influences rather than with primarily the offering of superior products or services to a marketplace. Unfortunately, this has had the consequence of reinforcing some rather distorted beliefs about what it takes to get ahead in business. It will take some time, perhaps even a couple of generations, before these distortions get substantially flushed out of the economic system.”
A New Policy Environment
Does the Essar Oil-Rosneft deal signal that the Ruia brothers – co-founders of Essar Group – have indeed been paying attention to Jaitley? The brothers – Shashi and Ravi – took a backseat at the fanfare that accompanied the Rosneft deal announcement. The frontman was Prashant – the son of Shashi Ruia. Said Prashant Ruia in an interview to business daily The Economic Times: “In hindsight, we could have been more conservative. But, in 2008-2009, the mood of the nation was to chase growth, build assets. The government encouraged that.”
“Distorted cultural norms arose during a period when business success was correlated with non-market influences rather than with primarily the offering of superior products or services to a marketplace.” –Jitendra V. Singh
“The Ruias have realized that they have no option but to have a close look at their portfolio and restructure in the classic BCG (Boston Consulting Group) way,” says Kavil Ramachandran, professor of family business and wealth management at the Hyderabad-based Indian School of Business. (BCG’s 50-year-old growth matrix divides businesses into “Cash Cows,” “Stars,” “Question Marks” and “Dogs.”) “I hope they will retreat to reorganize themselves and charge forward….”
“Given the stern position of the RBI and its ‘name and shame’ listing, the businesses [like Essar] probably have no option but to bring in new investors to deleverage,” says Rajesh Chakrabarti, professor at the Haryana-based Jindal Global Business School. “It is probably more about reacting in a different policy environment than a matter of generational shift of culture or strategy.”
He adds: “Taking strict action against major defaulters is definitely a most imperative step for the government and the RBI not only to help recovery from these firms, but also to fix the debt culture and accountability in the system in general. Accumulation of unpaid debt can destabilize the entire banking system, and it is important for government to signal its seriousness of intent regarding recovery.”
Action taken may be belated. But the intent has been evident for some time. “Nearly two years ago, RBI carried out an asset quality review over and above the annual inspection,” says Mukhopadhyaya. “To the bankers’ surprise, RBI handed them a list of 150 accounts for 15% provisioning (as NPAs). The RBI’s move was termed as subjective by many. This was a determined move to advise banks to classify more stressed assets as NPAs.
“The Insolvency Code 2016 and many other measures being taken are comprehensive steps to create an enabling environment to tackle the defaulting companies,” he adds. “One of the best things here is that the insolvency resolution is time-bound (180 days) and gives significant handle to the financial creditors.”
“Accumulation of unpaid debt can destabilize the entire banking system, and it is important for government to signal its seriousness of intent regarding recovery.” –Rajesh Chakrabarti
‘A Landmark Deal’
Analysts see the Essar Oil-Rosneft deal also as reflecting a decline in the importance of the U.S. in Indian business. Indian IT companies are reworking strategies, and in defense – the latest greenfield for joint ventures – other nations are stealing the show. The big U.S. investments announced recently have come from Pepsi, Coke and Amazon, and the spend is mainly on marketing. U.S. defense giant Lockheed Martin has signed an agreement with the Tatas for joint production of the F-16 Block 70 fighter jet in India. But, as financial daily BusinessLine points out: “U.S. President Donald Trump has opposed any move by American companies to shift manufacturing facilities outside of the U.S.”
Meanwhile, Russia is waiting with more. Not just in defense. The Essar-Rosneft M&A is Russia’s largest-ever foreign investment. It is the biggest Indian corporate takeover. And, for a change, there is no whisper of corporate raiders.
“This is a landmark deal,” says HDFC chairman Deepak Parekh. “It demonstrates the strong resolve of the Indian and Russian governments in strengthening economic, strategic and diplomatic ties.”
“In the past couple of years, India-Russia FDI flows have seen significant increase after declining flows prior to that,” says Chakrabarti. “The Rosneft-Essar deal is just the most prominent instance.”
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