IL&FS insolvency is rocking the Indian stock markets right now. The situation is so grim that the Modi government has now “nationalized” the company! They have bailed out a private limited company by using public money. The news is coming out that, as usual, LIC and state bank of India (SBI) are being coerced by the Modi government to bailout this beleaguered company.
The government has bailed out IL&FS, but it is just a ‘canary in the coal mine’. This is the domino whose fall will start the domino effect. There are many such companies whose books are leveraged beyond limits. As the bubble bursts, all the mass insolvencies will come to surface one after another. The whole Indian economy is like a giant castle standing on a quicksand of artificial growth generated by these companies. Artificial because such growth can’t be sustained for long. These activities have to be unwind one day. Modi government has bailed out IL&FS, but how many more such companies they can bailout? This is an impossible task and an undesirable one. The real solution of this problem is not a bailout. I will discuss the real solution below.
What happened to IL&FS?
The problem with IL&FS is, as usual, borrowing and spending beyond limits. The newspaper The Hindu reports this problem succinctly,
Simply put, the company borrowed many times its equity (rumoured to be between 10-18 times its equity) to fund its infrastructure projects, most of which bring in returns over 20-25 years. Making things worse, IL&FS’s borrowings were all repayable in the short to medium-term of roughly 8-10 years. Usually, these would be rolled over at the end of the term. Where IL&FS ran into trouble was in its projects stalling and not being completed due to various reasons ranging from statutory approvals not coming in, problems of land acquisition and projects simply becoming unviable as it happened in the case of power plants. With returns from these projects not coming in, IL&FS was forced to borrow more. Lenders pulled the plug leading to trouble for IL&FS.
Now, how is this borrowing possible? This is only possible when the cheap credit is available for borrowing. And that in turn is only possible when that credit is being created by the central banks, which are having monopoly over the creation of money and credit around the world today. If IL&FS borrowed from the Indian markets then RBI is the source of this credit, and if they borrowed from abroad then foreign central banks like the US Fed or the Bank of England of the European Central Bank (ECB) or the Bank of Japan etc., are the source. In any case, this debacle wouldn’t have happened if that cheap credit was not available for borrowing in the market e.g., just after the IL&FS debacle came to fore few days back, RBI has started printing and infusing rupees (RS 36000 crore right now) in economy again. Such infusion of money and credit is the source of such debacles. Such cheap unbacked credit can only generate artificial booms, which will ultimately turn in to recessions and depressions.
Not only this, RBI is again caught napping. RBI is the financial and money market regulator in India. If an important company like IL&FS can leverage too much without the notice of RBI then RBI is definitely not doing its job. In that case it should be abolished.
The only permanent solution of this problem is to allow these companies to go bankrupt. Let them sell their assets and repay their creditors. Or allow them to default and let their creditors take the pain of making a mistake of investing in such heavily mismanaged companies. Using tax payer, policy holder and depositor money, who are in no way responsible for this debacle, to bailout such companies is not only not going to work but is also an immoral act. The artificial boom that is created by RBI and other central banks has to be allowed to be liquidate itself so the economy can heal itself and go on normal path of growth again. For this a deep depression has to be allowed to run its course so that it can wipe clean all past malinvestment. The capital and production structure of the economy can only come on right path after this depression runs its full course. Any kind of bailout or further easing interest rates by RBI will only prolong the boom and the future bust will be even bigger and more painful. Such unsustainable activities can’t go on for long. It has to end, and it must be allowed to end. If not then people of India must stay ready to pay a very heavy price of this mismanagement of the economy by the RBI and its master government.