How about a rescue fund for firms?

Ajay Shankar | Updated on November 05, 2020 Published on November 05, 2020

Helping hand | A special fund would position firms for growth after conditions come back to normal   -  /iStockphoto

The government can consider injecting equity into outfits that were doing well before the pandemic

The economy is going through a historically unprecedented shock. All enterprises need help to survive this ‘ Act of God’. To the extent they survive, recovery would be better and speedier. The relief measures that have been put in place have this as a key objective. The Insolvency and Bankruptcy Code has been put on hold by amending the law.

Creditors cannot initiate bankruptcy proceedings for six months, extendable to a year, after the lockdown. Small and medium enterprises can avail themselves of government guaranteed loans to survive. After a general moratorium on debt repayment for six months, the Reserve Bank, based on the recommendations of the Kamath Committee, has issued guidelines for banks to undertake restructuring of loans.

However, severe challenges remain. The RBI, in a recent assessment, felt that the non-performing assets (NPAs) of banks could rise to 14.7 per cent (of all loans) in a worse case scenario from the March 2020 level of 8.5 per cent.

Pre-Covid Blues

Even before Covid, India Inc was in difficulty. A number of firms were going through the bankruptcy process, which was taking more time than stipulated. Banks were getting only around 40 per cent of their dues.

Getting buyers for firms was turning out to be more difficult than expected. The example of a big firm like Jet Airways illustrates the difficulties. Once the IBC process is again made operational next year, a surge in bankruptcy proceedings can be expected.

While small firms can now avail themselves of government guaranteed loans, large firms also need cash to survive. Many would be eating into their reserves. How rational would it be for them to take on more debt to retain staff and cover other fixed costs with so much uncertainty about how long the downturn would last? And how rational would it be for a bank to lend to an enterprise where the revenue streams are so much lower?

Banks’ dilemma

For banks and their borrowers restructuring of existing loans would also be a difficult challenge when there is so much uncertainty about likely revenues. If the recovery is not swift and ‘V’ shaped, then the crisis could be quite prolonged with banks having to deal with higher levels of NPAs and the economy with a large number of enterprises going into bankruptcy. Government revenues would remain subdued and reducing the fiscal deficit may become much more difficult.

In thinking about possible options, two popular maxims are relevant. First, there are no free lunches. Second, in a market economy, profits are private and losses are public. Accepting that there have been huge losses in the economy and that these have to be socialised is a good starting point.

Costs have to be borne by ordinary people either as tax payers through the government or through the banks as depositors. The key question is what would be an optimal way to apportion these costs and sequence them.

In doing so, the government and the RBI have to evolve a creative joint strategy. They have to assume a far greater role in steering the economy to recovery than what is normal in a free market economy.

The German example

Germany has introduced the largest relief packages relative to GDP in the developed countries. It has made a provision of €100 billion for purchase of stocks to save firms, such as Lufthansa, which were earlier doing well. This is in addition to support for payment of wages to enable firms to retain their employees.

Something similar in India may now be worth attempting. The government could get public sector banks in a consortium, or, an institution promoted by it such as the India Investment and Infrastructure Fund, to create a Special Fund to inject equity into firms which were strong and doing well before the Covid induced crisis.

This would also help them to survive, borrow, and be poised to grow well after conditions come back to normal. Over the medium term this would be the least cost option. Depending on the momentum of the recovery it could even be profitable.

Board-run firms

This, or another fund, created in a similar manner could be used to take over the firms which are up for sale through the IBC process and for whom there are no buyers. The resolution process has already arrived at a fair value for these enterprises. These firms can then be run as professionally Board managed companies.

This investment should give reasonable returns over time as these firms turn around. Banks would get closure on their NPA accounts.

These firms would become active and contribute to the recovery process. India would see the emergence of a large number of Board managed companies without promoters. This would add strength to the economy. Similar transitions from promoter run to Board managed companies happened in the US during the recovery from the Great Depression in the 1930s and in Germany during the economic recovery after the World War II. Both economies became far stronger as a result.

PSU bank recap

With these unconventional measures, the losses for the banks in the medium term would be minimised. The government needs to provide additional capital infusion in a timely manner to public sector banks so that they are able to respond promptly with confidence to the needs of their customers.

After recovery, further write downs by banks may be unavoidable as all enterprises may not be in a position to fully repay their outstanding loans.

A rational considered decision firm by firm would need to be taken. An assessment can be then be made of the feasible repaying capacity by extending the period of the loan and taking haircuts. In some cases bankruptcy proceedings may also be unavoidable.

Banks would need to take difficult decisions. Confidence to take commercial decisions with higher levels of uncertainty would be essential.

Economic pain can be reduced. The government needs to act in unorthodox ways to shore up banks and private enterprises. At the same time it needs to try and create demand on a massive scale.

The writer, a former Secretary, DIPP, Government of India, is Distinguished Fellow at TERI

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Published on November 05, 2020
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