Sucheta Dalal :Godhra and the financial mess (21 April 2002)
Sucheta Dalal

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Godhra and the financial mess (21 April 2002)  

It was only a matter of time before government stopped bothering to paper over the financial mess of state-owned undertakings.

Last week’s headlines suggest the government is so busy struggling to deal with the political fallout of Gujarat that it has no time to deal with financial defaults and quasi-sovereign obligations.

The assorted defaults have increased the nervousness of the financial markets, which is reflected in the steady decline in stock indices and the value of the rupee. Look at last week’s headlines:

The Industrial Finance Corporation of India (IFCI) has defaulted on a Rs 80 crore payment to United Commercial Bank, the Coal Mines Provident Fund and the Employees Provident Fund.

This is over and above its earlier default on SLR bonds this March and the numerous rollovers and re-investments to the tune of Rs 500 crore that have already been forced on banks and institutional investors.

Last week newspapers quoted finance ministry sources to say that government has no plans to bailout UTI’s Monthly Income Plans (MIPs).

Most of these 16 MIPs are assured-return schemes whose current Net Asset Value is far below the sum payable to investors.

If all the schemes have to be redeemed today, the shortfall could be as high as Rs 10,000 crore. If UTI is not bailed out and fails to pay the assured return, it would lead to litigation and a possible run on its other schemes.

Things are even worse with State government undertakings.

Last week, the Maharashtra Krishna Valley Development Corporation (MKVDC) defaulted on interest payment of Rs 74 crore. The rating agency CRISIL, reacted to this development by placing four similar state undertakings on a ratings watch with negative implications.

These are: MKVDC, the Vidarbha Irrigation Development Corporation, Konkan Irrigation Development Corporation and Tapi Irrigation Development Corporation and the sum raised is over Rs 2,100 crore.

Although retail investors have no direct investment in these bond issues, their investment could still be endangered by the defaults.

Let us look at MKVDC as an example. With no revenues in sight and a question mark over project completion, the MKVDC has already begun to default (State government officials say they will cover all dues by April 30).

Strangely enough, its borrowing programme remains unaffected by its inability to meet interest obligations. In fact, debt market brokers have horror stories to tell about how subscriptions are drummed up by the MKVDC and its dependents. For instance, MKVDC accepts subscriptions for several months after the official closing date of its bond issues.

It is continuing to accept subscriptions for a Rs 400 crore 14-per cent coupon issue that was to have closed on March 31.

They force subscriptions from co-operative banks, trusts, charities and other irresponsible investors either through the inducement of hefty kickbacks or through political pressure.

That the market considers these bonds completely unsafe is evident from the fact that there are no secondary market transactions in these bonds even at a steep discount.

Effectively, the MKVDC is nothing but a Ponzi scheme which is now beginning to come apart. While this writer has specific information about MKVDC, it is probably safe to presume that the other irrigation companies are no better. What is worse, the RBI, which supervises the bond market seems either unwilling or incapable of checking the sharp practices of their issuers.

Consequently, we have a situation where a bankrupt state governments guarantee the Ponzi schemes of their PSUs without any regulatory constraint.

Since the bonds are typically subscribed to by co-operative bank, trusts, charities, provident funds and nationalised banks, it endangers investors and depositors who probably think that their money is completely safe.

Credit rating agencies provide no safety guidance either. CRISIL reacted only after the default and has merely puts the bonds on a negative rating watch. The other rating agency CARE, has not even bothered to react and continues to give the bonds a high A rating.

In any case, the rating does not reflect the earning capability of these PSUs, they are based on an ‘unconditional and irrevocable’ guarantee of the Maharashstra government.

To CRISIL’s credit, it has downgraded Maharashtra’s credit rating, despite sate pressure and the fact that a World Bank-CII study places Maharashtra among the top two investment destinations in India.

But the situation is getting out of hand. This becomes evident when you consider Maharashtra’s internal debt has reportedly multiplied five times to Rs 27,105 crore in the last two years. An RBI study on contingent liabilities and guarantees by states also paints a grim picture. It says that the aggregate outstanding guarantees for 17 major states in India have risen from Rs 40,318 crore in 1992 to Rs 105,739 crore in the year 2000.

What is more disturbing is that government is not attempting to deal with the situation. The RBI is worried but its oversight has always been ineffectual.

It set up committees and commissions studies that recommend, among other things, a ceiling on guarantees by states and risk-sharing by banks and financial institutions.

These safeguards have not been implemented and the RBI also seems incapable of clamping down on state-sponsored Ponzi schemes.

Recent defaults suggest that it may already be too late to retrieve the situation but the damage control exercise has to begin now. If not, trusts, charities, retail investors and unit holders will once again have to turn to the judiciary for direction when the regulators and the executive have failed to fulfil their statutory responsibilities.

-- Sucheta Dalal