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Posted on 08-Feb-2019 Comments  0

Repo Rates

RBI cuts repo rates by 25 bps and does a lot more

The February monetary policy did spring a surprise. The general consensus in the market was that the RBI would shift its stance to neutral. However, the MPC went one step ahead. It not only shifted the stance to Neutral but also cut the repo rates by 25 bps on the back of lower inflation estimates. But, this policy was significant in more ways than one.

First, the rate cut story

The RBI voted 4-2 in favor of a rate cut. Dr. Viral Acharya and Dr. Chetan Ghate were in favor of a status quo on rates. The logic for the rate cut was three fold. Firstly, CPI inflation had fallen to 2.19% in December and the RBI estimates that the weak inflation trend would continue. Despite the fall being limited to food, the policy decided to focus more on headline inflation rather than on core inflation. Core inflation (excluding food and fuel) was still high at 5.5%. It also means that the policy focus in future will be on headline inflation and not on core inflation. Secondly, the RBI clearly decided to put growth over price control. The IIP had been under stress and the global slowdown is also likely to rub off on the Indian economy. Thirdly, the US Fed had given a very dovish view on rates. The CME Fed Watch Tool is now almost factoring in zero rate hikes in this year. So the worry of rate differentials being compressed is also not a real problem. The situation was ripe and this actually reverses part of the rate hike implemented last year.
Boost for FPIs and NBFCs

The policy statement, interestingly, had a lot more of interesting tidbits for the markets this time around. Firstly, foreign portfolio investors (FPIs) will now be freed from group exposure restrictions. Currently, FPIs cannot invest more than 20% of their debt corpus in India in a single business group. That has been relaxed and rightly so because there are enough reputed fund managers to take such decisions. Secondly, the RBI has also ensured that the liquidity taps to the NBFCs are kept open. Normally, when banks led to NBFCs, it is assigned 100% risk weight for capital adequacy purposes. This has now been relaxed and the bank shall be free to assign risk weights based on the credit rating of the NBFC. For banks, it now becomes cheaper to lend to NBFCs.

A boost for the IBC too

With a view to giving a boost the bankruptcy resolution process, the RBI statement has also allowed ECBs for bidders. Currently, ECBs are not permitted to be raised to repay domestic debt. However, the RBI has now made an exception for IBC bidders. Potential buyers can raise funds via ECBs to repay the domestic debt of the stressed companies. This enables these bidders to raise money at a low cost. This ECB relaxation is only for the purpose of IBC and it should certainly be a leg up for the NCLT resolution process!

Goodbye RCOM

The end of Reliance Communications as we know it

Few companies in the Indian context have imploded as gradually yet as inexorably as Reliance Communication. The company has been blaming the NBFCs like Edelweiss Finance and L&T Finance for disposing shares in the market with malicious intent. However, the financers had little choice with the stock price of RCOM falling vertically. Pledged shares, as we have seen in the past, can be a double whammy for companies and RCOM and the entire ADAG group was no exception.

It all began with CDMA

When Reliance Communications was first launched back in 2003, it was way ahead of its time. CDMA as a technology was much smarter than GSM. With an unbeatable offering of price, service and network, Reliance Communication made an offer few could refuse. Things did change quite rapidly for the company post 2009. With the introduction of smart phones and mobile date explosion, the benchmark for mobiles shifted towards 4G and 5G. But, CDMA technology was designed only to run on 2G and 3G. To that extent, the CDMA technology was just unprepared for the smart phone explosion. Where RCOM erred is in holding on to their CDMA technology for too long. By the time they decided to venture into GSM, the space was already crowded. RCOM had already run up a mountain of debt and was left holding a lot of worthless assets. From there it was downhill!

Jio rubs it in

If smart phones and 4G networks did RCOM in, the real problem was actually precipitated by the entry of Reliance Jio in late 2016. Jio launched plans at rates that were not heard of before. With an endless flow of money from refining and petchem, Reliance could afford to play the waiting game longer than the others. The reaction was almost immediate. Vodafone rushed to merge with Idea and Bharti picked up the Tata Tele business virtually for nothing. RCOM did manage to sell his assets and towers, lock, stock and barrel to Jio. However, it was pressure from creditors that finally pushed RCOM to opt for bankruptcy filing. What happened to RCOM from here on? 

Now for negotiated sale

The choices are quite limited for the ADAG group. Once they file for bankruptcy, RCOM still has 270 days time to work out a mutually agreeable settlement with the creditors. It is entirely possible that a potential buyer may squeeze the banks for a much higher hair cut to the tune of 70-75% and walk away with the RCOM assets at a real throwaway price. For Anil Ambani, the damage to the entire growth is already huge. The group market cap since the split has fallen from $48 billion to $4 billion! During the same period, the MDAG market cap has doubled to $100 billion. Over to the NCLT!

Essar Steel

One more delay and the Essar Story gets more confusing

The 2008 Hollywood movie, The Curious Case of Benjamin Button, chronicles the story of a man who reverse-ages. He starts out as an old and then becomes younger as years pass by. In a way that is what Essar Group reminds of today! A group that had almost given up on all its businesses has suddenly come back to claim its rightful place in the pantheon of Indian family businesses. But first the Essar Steel controversy!

What happened to Essar Steel?

With an unsustainable debt burden of over Rs.50,000 crore, there was little choice for Essar but to go into IBC bankruptcy resolution. After several rounds of bidding and several rounds of disqualifications, it was Arcelor Mittal that had emerged as the highest bidder at Rs.42,000 crore. Even as the Committee of Creditors (COC) agreed to the offer, Essar has made a counter offer. In fact, the promoter group has now agreed to buy out the company for Rs.54,000 crore that would not only full pay the dues of the banks but also the operational creditors. While the COC and the NCLT have expressed doubts, there are two things that are going in favor of Essar. There is a precedent of Ruchi Soya promoters being involved in the bid meetings and Essar may be entitled to demand the same. Secondly, the entire NCLT had been skewed against operational creditors. That could be a very smart and critical card for Essar Group to play.

Should Essar get a chance?

The moot issue is whether the NCLT should go rigidly by rules or should it consider the larger interests of the stake holders. Here stake holders include the banks and the operational creditors. Frankly, there are not clear answers but considering that the NCLT process is still evolving, the Essar Group may actually justify being given another chance. Also, it addresses the very critical issue of banks versus operational creditors. Also, many smaller banks in the consortium have often complained that the larger banks tend to dominate decision making in the consortium. That too can be addressed. Even as it goes against the grain of bidding, the Essar promoters may actually deserve a chance.

Where does the money come?

That is actually the million dollar question. If Essar had the money, then why did they not pay the creditors and avoid the NCLT altogether? But there is also a new twist to the tale. ICICI Bank and IDBI want to invoke the personal guarantees given by Essar promoters for their outstanding dues pertaining to Essar Power. If that were to happen then the ability of Essar promoters to bring in the requisite funds will be seriously compromised. The moral of the story is that Essar is likely to be a complex case study. For the NCLT process and for industry, there could be some sharp learning value!




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