Corporate India has to Get Ready for a Wave of Defaults

In recent days, the announcement that the Energy Giant, Suzlon, has defaulted on its convertible debt has sent shockwaves through the investment and financial community. However, this is just the tip of the iceberg and studies by the ratings agencies have shown that more defaults of such magnitude are in the offing.

Indeed, an article in the popular business press has called this trend a “Wave of Titanic Defaults” that corporate India has to get ready.

In this article, we examine this trend by discussing the genesis of the problem, the implications for the companies and the creditors, and the effect such defaults would have on the overall economy and business confidence.

Before launching into the discussion, it would be pertinent to note that even Kingfisher is close to default and it is being kept afloat mainly due to the fact that the lenders are unwilling to be the first one to pull the plug. In addition, the owners of the Deccan Chargers team defaulted as well.

The root cause of this problem is that in the boom years of the last decade, Indian companies rushed to avail themselves of foreign currency debt because of the difference in interest rates between India and other countries. Since those countries had low interest rates as compared to India, it made eminent sense for the Indian corporates to borrow from there and invest here.

Further, since western bankers viewed India and China as emerging markets that had high growth potential, they were eager to lend to Indian companies because of the rate of return that they were getting. Apart from this, the booming Indian economy that was growing at an annualized rate of around 8 percent provided enough leverage for these companies to be able to pay back the debt.

The situation has changed with the global economic crisis and the end of growth happening simultaneously. Now, the corporates are saddled with unpayable debt that has implications for the lenders and the business confidence.

The previous paragraph discussed the foreign exchange debt. This means that the depreciating rupee has put additional pressure on these companies to service the debt as well as pay it back when it comes due. Even domestic debt is maturing which means that there the “Titanic Wave of Defaults” that the business magazine predicted might actually come true.

In this situation, it would be prudent for the lenders, investors, and anyone who invests in these companies through the stock markets to be cautious and follow the developments closely so that they are prepared for the outcome. The impact on business confidence is severe as well since defaults invariably lower the confidence index and make the process of doing business that much more difficult.

Finally, the overall economy is affected since the mountains of debt means that these companies would have to set aside a substantial portion of their earnings towards debt servicing leaving very little capital for growth and investment.

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