IL&FS Crisis: Impact on the Indian Economy

Last Updated at: October 23, 2019
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IL&FS Crisis Impact on the Indian Economy

The IL&FS crisis has been in the news for almost a year now, triggering several effects on the Indian economy such as lack of infrastructure funds and sharp downgrading in credit assessment. In this post, we analyse several dynamics that led to the collapse of the Infrastructure Leasing and Financial Services (IL&FS) and its repercussions on the Indian economy.

What is IL&FS?

IL&FS stands for Infrastructure Leasing and Financial Services Ltd., which was also the holding company of the larger group known as the IL&FS Group, which dealt in investments as its core business. IL&FS was founded in 1987 with major equity from Central Bank of India, Unit Trust of India and Housing Development Finance Co to fund infrastructure projects since most contemporary banks of the time were focused on corporate funds rather than infrastructure-based funds. IL&FS’s major shareholders include Life Insurance Corp of India holding 25.3% stake, State Bank of India with 6.42%, Japan’s Orix Corp holding 23% and the Abu Dhabi Investment Authority with 12%.

It was registered with the Reserve Bank of India as a ‘Systemically Important Non-Deposit Accepting Core Investment Company’, with over Rs 1,15,000 crore of assets and Rs 91,000 crore of debt, and looked very promising, to begin with. However, IL&FS has been called a “shadow bank” – a term used to refer to intermediaries in the banking and finance segment that provide similar services as that of traditional banks, however, they are not under similar regulation.

Antecedents that led to the failure of the IL&FS

The following factors can be attributed to the huge financial crisis that IL&FS found itself embroiled in. While some of these are economic reasons purely beyond the control of the enterprise, most of these factors were a direct result of manipulation, evasion and financial imprudence. Let’s take a look at them:

Too much debt in the company – This was the single most important factor that led to the fall of the company. With a consolidated debt of around Rs 90,000 crores, the company was simply unable to find resources to pay its debt, and found itself in an asset-liability mismatch, which refers to a situation where there is a lot of liability on the entity in the form of loans (both short term and long term), creditors, commercial papers (an unsecured form of short term money-raising instrument from the market) as compared to fewer assets, in the form of receivables, cash or inward-investments.

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It is said that the crisis came to light in August 2018 when the company found itself unable to service a debt of Rs1000 crore owed to SIDBI – the Small Industries Development Bank of India. This debt failure led to an investigation that unearthed many more reasons for the default of the company.

Mounting losses in the infrastructure sector – Financial analysts believe that longer the gestation period of the project (that is, the time taken for a project from the planning stage to final execution), higher are the chances of risk. This proverbial prediction turns out to be true in case of the investments made by the IL&FS. Traditionally, the company has begun investing in power, road and water projects that have gestation periods of anywhere between 8 years and 15 years. The company would get the project refinanced, that is availing fresh loans, but in the recent few years, with the NPA crisis troubling most major banks, IL&FS was left to look for alternative sources of funding, as short term loans from the market, which it naturally was unable to pay.

More than 60% of the debt owed by the company was in the road building, power and waterworks projects. These projects have often been found to be plagued with several issues such as complications in land acquisitions, perpetual disputes between contractors and the government leading to litigation and arbitration proceedings, long project delays, huge escalation costs, shortage of availability of labour and raw materials etc.

Manipulation in credit ratings

The fact that despite impending financial challenges and irregularities in the financial statements of the company, most credit rating agencies gave a AAA rating to the company is a huge surprise. Forensic audit investigations are done so far reveal that email exchanges between credit rating agencies (such as Crisil and Care) revealed the poor financial health of the company, but the final certifications revealed no downgrading, which was only done last year, in 2018.

Tracing impact on the Indian economy

On individual investors

Since IL&FS had begun raising huge amounts of money from the market by way of a commercial paper, which is an unsecured debt meant for immediate financing needs, the worst affected are investors that include mutual funds, individuals, banks and other companies, which offered loan by way of inter-corporate deposits.

On infrastructure projects

The IL&FS crisis is likely to have a major effect on current infrastructure projects. For example, in Maharashtra, the government officials believe that the refusal of banks to offer loans on continuing work on the highway for the Mumbai-Nagpur Communication Expressway is a direct result of the IL&FS crisis, which has made banks extremely wary of releasing funds for the road project. IL&FS’ existing projects have also faced a critical blow, some of these were in the form of a PPP model (Public Private Partnership) for developing national highways and connecting roads.

On credit rating agencies

The lack of transparency, accountability and subversion of credit rating agencies which are supposed to exercise principles of prudence, caution and utmost integrity, have been highlighted by the crisis. It is likely that the government would tighten its grip over credit rating agencies and prescribe greater punishments for frauds.

On NPA crisis and the spillover on the economy

Being an NBFC, a non-banking financial company, the RBI did not exercise as much control over operations as in the case of traditional banks. The default in payment of loans of Rs60,000 crores will only add to the current financial distress that the banking sector is facing due to rising non-performing assets. As a result, the spillover on other segments of the economy is undeniable.

There is a need for a stronger regulatory regime for NBFCs, which should instead of investing in high risk and return projects be encouraged to invest in moderate growth and profitability projects. The Central government also needs to find innovative and alternative models of financing large infrastructure projects, while also improving corporate governance standards for credit rating agencies.

 

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    Avani Mishra is a graduate in law from the National Law Institute University, Bhopal. She qualified the Company Secretary course with an All India Rank 1 and is a recipient of the President’s Gold Medal for her academic distinctions. She also holds a B.Com degree with a specialization in Corporate Affairs and Administration.