The great Indian debt time bomb

time bombVivek Kaul

On November 17, 2014, Adani Enterprises put out a statement saying: “Adani Mining, the Australian subsidiary of Adani Enterprises, and the State Bank of India (SBI), the country’s largest lender, have today signed an MOU in the aftermath of the successful Brisbane G20 Summit…The MOU provides for a credit facility of up to $1 billion USD subject to the detailed assessment of the company’s mine project at Carmichael, near Clermont in Western Queensland.”
This MOU was questioned in the media. The basic question asked was: Should Adani Enterprises, a company already having a lot of debt, be allowed to raise more debt? Further, the environmental concerns around the mine were highlighted as well.
As on September 30, 2014, the total debt of the company stood at Rs 72,632.37 crore.  It had shot up by Rs 7653.33 crore from where it was on March 31, 2014.
The total operating profit of the company over the last four quarters was at Rs 8,999.92 crore. The interest that it paid on its debt was Rs 5,733.77 crore. This means an interest coverage ratio of around 1.57.
Interest coverage ratio is essentially the earnings before interest, taxes and exceptional items (or operating profit) of a company divided by its interest expense. It tells us whether the company is making enough money to pay the interest on its outstanding debt.
If we look quarterly data, the situation becomes more interesting. The interest coverage ratio of the company was 2.67, for the period of three months ending March 31, 2014. It fell to 1.58 as on June 30, 2014. And for the period of three months ending September 30, 2014,it stood at 1.12.
An interest coverage ratio of close to one basically tells us that the company is making just about enough money to keep paying interest on the debt that it has. Clearly, a worrying situation.
Ideally, the interest coverage ratio of a company should be over 1.5.
What this tells us is that Adani Enterprises isn’t in the best financial shape. After some criticism in the media, Arundhati Bhattacharya, the chairman of SBI, said that the loan
will go through “proper due diligence both on the credit side as well as on the viability side.” She also said that the board of SBI had yet to take a call on the loan. “The board will take a call and then only the loan will be sanctioned,” Bhattacharya said.
Bhattacharya further clarified that a new loan to Adani Enterprises will be given only after the company had repaid portions of the earlier loan given to them by SBI. After that had happened, the fresh lending to the company would work out to only $200-400 million.
As far as environmental concerns went, Bhattacharya said that she had been assured by the Queensland government (where the Carmichael mine is located) that there were no environmental issues around the project.
News-reports appearing in the media clearly suggest otherwise. There seem to be environmental concerns around the mine, as the project is adjacent to the Great Barrier Reef. A recent news-report in
the British newspaper The Guardian said that the Rainforest Action Network, a US environment group, had written commitments from US banking giants Citigroup,Goldman Sachs, and JPMorgan Chase, to not back the project.
Before this several British banks had also ruled out funding the project. The news-report pointed out that “several avenues of finance have already been shut off to the $16.5bn project. Deutsche Bank, Royal Bank of Scotland, HSBC and Barclays all ruled out funding the development, before the US banks’ refusal.”
Another recent report in The Guardian points out “construction of Australia’s largest ever mine[i.e. the Carmichael mine] will be well underway before its impact upon the environment is known, with a requirement to replace critically endangered habitat razed by the project pushed back by two full years.”
So, clearly there are environment concerns around the mine, irrespective of what Bhattacharya has been told by the Queensland government. Nevertheless, it was nice to see Bhattacharya come out in the open and clarify that SBI would go through proper due diligence before deciding to give Adani another loan.
If other public sector banks had done that in the past, they would not be in a mess that they currently are in. In August 2014, the finance minister
Arun Jaitley had told the Parliament that bad loans in the banking system had risen to 4.03% of the advances in 2013-14. The number had stood at 3.42% in 2012-13 and 2.94% in 2011-12.
In fact, the situation is much worse for public sector banks. As on March 31, 2013, the gross non performing assets (NPAs) of public sector banks had stood at 3.63% of the gross advances. By September 30, 2014, this had jumped up to 4.80% of the gross advances. During the same period the gross NPAs of private sector banks has been more or less stable at 1.8% of gross advances.
This is something that the Reserve Bank of India points out in
the Financial Stability Report released towards the end of June 2014, as well. The stressed advances of the Indian banking system stood at 9.8% of the total advances. For public sector banks the number stood at 11.7%. What this means in simple English is that for every Rs 100 given by Indian banks as a loan nearly Rs 9.8 is in shaky territory (for public sector banks the number is at Rs 11.7) The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank).
The report further points out that “There are five sub-sectors: infrastructure (which includes power generation, telecommunications, roads, ports, airports, railways [other than Indian Railways] and other infrastructure), iron and steel, textiles, mining (including coal) and aviation services which contribute significantly to the level of stressed advances.”
These sectors (especially the infrastructure sector) are dominated by crony capitalists, who were able to get loans from public sector banks, and are now unable to repay them.
An excellent example here is that of Lanco Infratech. As on March 31, 2014, the company had total loans amounting to Rs 34,877 crore. Against this the company had a shareholders’ equity of Rs 1,457 crore. This means the company had a debt to equity ratio of around 24. Not surprisingly for the period of three months ending September 30, 2014, the company had an operating profit of Rs 317.23 crore and finance costs of Rs 773.02 crore.
What this clearly tells us is that the banks giving loans to this company did not do any due diligence or were simply under pressure to hand out loans. This is not surprising given that its founding Chairman L Rajagopal was a member of parliament from Vijaywada on a Congress Party ticket, in the last Lok Sabha.
There are many other companies run by crony capitalists which are in a similar situation and are unable to repay the loans they had taken on. This has led to trouble for banks, particularly the public sector banks.
Uday Kotak, Executive Vice Chairman and Managing Director of Kotak Mahindra Bank,
in a television interview earlier this year had estimated that the Indian banking system may have to write off loans worth Rs 3.5-4 lakh crore over the next few years. When one takes into account the fact that the total networth of the Indian banking system is around Rs 8 lakh crore, one realizes that the situation is really precarious.
To conclude, it is worth recounting here what the economist John Maynard Keynes once said “If you owe your bank a hundred pounds, you have a problem. But if you owe your bank a million pounds, it has.”
The modern day version of this quote was put forward by the
Economist magazine when it said “If you owe your bank a billion pounds everybody has a problem.”
The point being that any bank has to be very careful when giving out a large loan. Indian public sector banks seem to have forgotten that over the last few years. And now we have a problem.

The article originally appeared on http://www.equitymaster.com on Nov 24, 2014

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About vivekkaul
Vivek Kaul is a writer who has worked at senior positions with the Daily News and Analysis(DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System , the latest book in the trilogy has just been published. The first two books in the trilogy were published in November 2013 and July 2014 respectively. Both the books were bestsellers on Amazon.com and Amazon.in. Currently he works as an economic commentator and writes regular columns for www.firstpost.com. He is also the India editor of The Daily Reckoning newsletter published by www.equitymaster.com. His writing has appeared across various other publications in India. These include The Times of India, Business Standard,Business Today, Business World, The Hindu, The Hindu Business Line, Indian Management, The Asian Age, Deccan Chronicle, Forbes India, Mutual Fund Insight, The Free Press Journal, Quartz.com, DailyO.in, Business World, Huffington Post and Wealth Insight. In the past he has also been a regular columnist for www.rediff.com. He has lectured at IIM Bangalore, IIM Indore, TA PAI Institute of Management and the Alliance University (Bangalore). He has also taught a course titled Indian Economy to the PGPMX batch of IIM Indore. His areas of interest are the intersection between politics and economics, the international financial crisis, personal finance, marketing and branding, and anything to do with cinema and music. He can be reached at vivek.kaul@gmail.com

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