Sucheta Dalal :Rescuing A Sinking IFCI (1 July 2002)
Sucheta Dalal

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Rescuing A Sinking IFCI (1 July 2002)  

Is the government doing to IFCI Ltd what it did to Unit Trust of India? Which is, to deny the scale of its financial difficulties and evade responsibility until it is too late?

A few weeks ago, IFCI made news when it was reported (wrongly) that Mckinsey & Company had recommended its merger with the Industrial Development Bank of India. Mckinsey promptly denied the report, but its exact recommendations still remain a secret. Mckinsey was appointed by IFCI, not entirely of its own volition but under pressure from the finance ministry, which was keen on finding a permanent solution to the problem. But now that it is time to act on McKinsey’s advice, informed sources tell us that the government is shying away from the decisive action that is required.

Meanwhile time is running out for IFCI. On Friday, it announced that its net losses had trebled during FY 2000-01 to Rs 884.70 crore (up from Rs 265.93 crore the previous year). Also total income dropped 22 per cent to Rs 2248.65 crore. Although IFCI cut expenses and made efforts to improve recoveries, it is nowhere near enough. Its results are in line with all the negative indicators emanating from the company over the last few months. Last year the government had cleared a bailout package of Rs 1,000 crore for IFCI with the help of banks and insurance companies. But it was grossly inadequate and IFCI was back on the ropes this March and began defaulting on redemption commitments. In May all three rating agencies — ICRA, CARE and Fitch downgraded its long term borrowing to junk (or near junk) status. However, it could still use its clout as a government institution to persuade Bank of Baroda to roll over a borrowing of Rs 100 crore. Other banks were not so accommodating and refused to offer any rollovers without a government guarantee. So, IFCI has followed the UTI route and asked for a Rs 1,200 crore government guarantee to help it borrow afresh and to meet redemption demands.

The problem is that there are several redemptions bunched together over the next 12 odd months. There is a Rs 350 crore redemption coming up in October and another Rs 700 crore of floating rate notes due for maturity later in the year followed by others. Sources close to the company estimate IFCI’s liabilities at a whopping Rs 6,000 crore and the institution has no clue where the money is going to come from if the government refuses a bailout.

So far, the government has been talking tough and refusing to oblige. What it has however done is to promulgate an ordinance to enable the setting up of Asset Reconstruction Companies and making it a tad easier to recover bad loans. This is also in line with the Mckinsey suggestion, which is reportedly to separate the good assets from bad ones and move the latter to an ARC. According to newspaper reports, the good bank would focus on mid-size companies and concentrate on asset financing, IPO management, syndication, project finance, receivable financing, mergers and acquisition and project financing. An ARC called Asset Care Enterprise has already been capitalised for Rs 20 crore will handle the bad assets.

However, this raises three issues. Firstly, even if IFCI is split into a good institution and a bad one, does it make sense for it to continue? Development Financial Institutions have long outlived their utility, and the good institution too will have to be wound up or merged with a willing bank. This will leave only the bad institution or the ARC. Secondly, the split can only work with strong government support and we are talking about several thousand crores of financial support here. Thirdly, the ARC is a new concept and will depend on the will of the institutions to recover bad loans. Given that IFCI’s losses are the result of at least two of its past chairmen deliberately and reckless lending money to friendly companies, there is no guarantee that things will work any better in future. Indian DFIs cannot improve unless they are freed from political interference and top appointments are handled by an independent search committee, rather than dictated by politicians. Even this will get limited results without a carrot and stick policy. Institutional heads must be given performance-based emoluments and at the same time made personally accountable for their dubious lending and write-offs.

A solitary UTI chief in the docks (even that investigation has made no progress over the last year) that too after bringing a giant institution to its knees and causing losses to millions of investors is hardly a strong enough deterrent. If IFCI is allowed to sink, tens of thousand investors will lose a lot of money again. Many retail investors continued to invest in IFCI bonds even until a few years ago. Other investors were provident funds, trusts, charities etc. The government may argue that Indian investors will perforce have to become a lot smarter about their investments. But what about provident funds, where government trustees (again with no personal accountability) make decisions on behalf of investors?

IFCI’s financial problems have never been a secret, but it has been allowed to fudge and hide the true extent of its losses. Can the government walk away from its responsibility? In IFCI’s case, it is going to be a lot more difficult than with UTI. That is because IFCI is notified under section 4A of the Companies Act, which provides an implicit guarantee with regard to investments in it. This gave its borrowings the status of permitted securities in which provident funds, gratuity and superannuation funds could be invested. It also gave it preferential treatment in terms of the risk weightage attached to its bonds and most importantly, protection from disclosure norms. In fact, it was not allowed to divulge information relating to its borrowers. This means that even if government dares to renege on its responsibility, investors have good grounds to file litigation and claim their dues.

Unfortunately, that is a slow and tedious process with no guarantee that the courts would force government to pay interest on the delayed redemptions or pass strictures against the government for harassing investors. The biggest irony is that even if government does bail out IFCI, taxpayers in general will be the losers because it is their hard earned money that will be used to fund careless investors and crooked businessmen.

-- Sucheta Dalal