Analysis

India: the upside of downside risks - Insolvency opportunities

  • Asia Pacific
  • India
Reema Bhattacharya

Reema Bhattacharya

India: the upside of downside risks - Insolvency opportunities


Distressed assets usually attract niche investors skilled in the art of the turn-around. However, when those assets surface in emerging markets that are littered with opaque legal systems, vested stakeholder interests and large doses of corruption, investors often shy away.

Enter India – which holds the world’s worst non-performing loan pile, accumulated over decades of unscrupulous lending by state-run banks and non-banking financial companies (NBFCs). The South Asian giant is now eager to present its $200bn bad debt problem as an unprecedented investment opportunity for foreign companies, and in doing so kickstart its economic growth. As expected, in its 1 February annual budget the government announced major tax concessions and other incentives particularly for investors in the cash strapped infrastructure sector which holds the lion’s share of all stressed assets in the country. This is bound to generate new euphoria among economic pundits and financial analysts who have spent the last few years doing complex arithmetic on the scale and size of the country’s debt opportunity. But it remains to be seen whether India’s existing regulatory regime will be sufficient to untangle distressed assets from the legacy of corruption and corporate malfeasance, whilst reassuring weary investors.

India’s first effective insolvency law – the Insolvency and Bankruptcy Code (IBC) introduced four years ago – has had mixed results so far. The IBC set out to change the ground rules that shape India’s corporate distressed asset landscape by putting the country’s largest debtors into a time-bound bankruptcy process (of 270 days) for resolution of bankruptcy cases. However, it did not contain any additional provisions to limit the scope of litigation between related parties in each case. Recalcitrant defaulters have utilised these loopholes to create protracted legal hurdles and delays in the insolvency resolution process which have compelled the government to further extend the total resolution period to 330 days. In fact, lengthy litigation has meant that India’s most high-profile bankruptcy case – involving the $6bn sale of Essar steel to Arcelor Mittal – has taken more than two years to be resolved. Although Essar’s eventual resolution was a big victory for the new law, it highlighted the extent of litigation risks, not to mention cost and time overruns facing foreign investors attempting such acquisitions.

India’s current investment climate is a bemused polemic of hope and apprehension. Bullish investors are lining up outside beleaguered institutions and NBFCs, eyeing their vast portfolio of investments whilst contending with niggling anxieties about potential criminal liabilities and the associated reputational risks that encumber most of their marquee assets. After all, Infrastructure Leasing & Financial Services Limited (one of the country’s largest NBFCs in infrastructure development and finance, which collapsed last year) is being jointly investigated by the Ministry of Finance’s Enforcement Directorate, the Serious Fraud Investigation Office (SFIO) and tax authorities over allegations of fraud and criminal misconduct.

To address these concerns, the government recently amended the law to ringfence investors of distressed assets from criminal proceedings brought against the previous management. This will boost investor confidence in insolvency legislation and the broader viability of investments by ensuring that the value of distressed assets is not further eroded. Nonetheless, the amended law remains as yet untested. Its efficacy will depend on the interpretation of superior courts and precedent-setting rulings.

The government is also expected in the months ahead to further strengthen the bankruptcy law to address the deepening debt crisis in the NBFC sector. However, its recent decision to expand the IBC’s scope to include NBFCs whilst concurrently fixing existing glitches in the law is likely to put the bankruptcy resolution process under significant strain in the coming months. Existing structural challenges (such as lack of manpower) that have long limited the tribunals’ ability to efficiently process and close cases have not yet been fixed and adding NBFCs to the pot will only exacerbate inefficiencies.

All things considered; the IBC is a sincere reform effort aimed at fashioning India’s distressed assets landscape into a lucrative insolvency industry. Despite the current headwinds facing the Indian economy, foreign investors have good reason to be sanguine about the increased potential for M&A activity in the coming years, especially given the Modi government’s strong desire to iron out remaining wrinkles (as the flurry of amendments appears to indicate). That said, foreign investors should calibrate their level of enthusiasm based on whether such tweaks are accompanied by more structural reforms (such as through additional bankruptcy courts) to overcome the chronic delays that typically characterise the Indian legal system. Investors will also need to conduct independent assessments of the stressed asset books to ward off the potential for heightened regulatory scrutiny down the line. Before rushing to snap up distressed assets in India’s currently depressed economy, investors should put in place appropriate risk mitigation measures. Only then can they make the most of India’s great insolvency opportunity.

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