The IL&FS case is more complex than the Satyam implosion

IT was expected that the government would not let IL&FS go down the tube. That has become evident now that the government has superseded the board and banker Uday Kotak has been appointed non-executive chairman. The government has said that there would be no further loan defaults. It has also sent the matter to NCLT. The swiftness with which it has acted merits an analysis. Perhaps, it was the fear of contagion and the way debt and equity markets were reacting everyday, which prompted the government to act. The change of board members is just a first step. This is effectively a Satyam-like rescue operation – on that occasion the government had taken over and appointed Deepak Parekh to the board. There are many questions specific to IL&FS and the broader issue of infrastructure financing in India, which the government will have to look into before the issue can be considered resolved.

For one, a triple ‘A’ rated paper, which was assumed to be quasi-government paper, was downgraded to default category overnight. This had led to situation where banks were not willing to subscribe to commercial paper of non-banking finance companies. There was a kind of freeze in the debt market. Policymakers need to focus on how to de-freeze the debt market. Steps should be taken without delay so that the debt market has the confidence that any paper of IL&FS will be honoured without any haircut. That would be half the problem solved. As anyone knows, confidence is the key to stability in financial markets. While the restructuring of IL&FS goes on, there is a bigger issue that policymakers need to look at and this concerns the whole eco system of infrastructure financing.

The IL&FS case sends some pointers. One is that on revenue of Rs 18,000 crore the total debt stood at Rs 91,000 crore. So, will the government hawk individual entities like the three listed companies under the IL&FS holding company? Will it sell subsidiaries? In essence, the mess is much more complex than was the case with Satyam.

What happened to IL&FS is just a symptom. Most infrastructure projects need financing for 15-20 years. In India, the maximum loans that banks give for any infrastructure project are for 8-10 years. So, every 8-10 years both the infrastructure project and the financial institution financing that project need to go for re-financing. That is the period where the risk of asset liability mismatch arises. That is what happened to IL&FS.

India needs to develop the market where interest rate risk can be assessed and priced in a financial instrument for a period of more than two decades. It is only when the financers do project work without any problem that infrastructure projects would work smoothly. An issue that emerges from this episode is that there are institutions, both public and private, which can be classified as “too big to fail”. In fact, one of the arguments, which the government gave at the NCLT hearing, was if IL&FS was to fail, it would have a bearing on the economy and some mutual funds would get into trouble. Against the backdrop of the IL&FS episode, the government should identify institutions that are regarded as “too big to fail” and develop a system where the health of these institutions is assessed at regular interval. That would prevent a similar situation from arising every few years.