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Expert view

The debt conundrum: Raja Lahiri

High corporate governance, trust creation with the bankers could solve debt issues

The growth aspirations of lot of Indian companies have been met by raising debt both in India and overseas countries. Debt has been taken for expansion, new market penetration and overseas M&A. There have been sectors like infrastructure, power, commodities, etc that have been fairly active in overseas markets and have raised debt in the past.

With falling commodity prices along with inherent execution risks in the infrastructure sector, there has been mismatch in cash flows in terms of cash inflows from the growth assets and cash outflows to service the underlying debt. Moreover, with potential interest rate hike expected in the US market, along with the inherent rupee volatility factor, debt servicing becomes crucial for Indian companies.

Impact on cash flows due to seasonal business cycles and falling commodity prices: Businesses go through cycles and especially in commodity sector like metals and mining, we have seen gradual softening of global prices driven by slack in global demand. This gradual softening has led to pressure on earnings and cash flows of companies. However, the external borrowings were taken considering much higher earnings expectations which has led to a mismatch in the rate of return on projects and interest rates.

Choice between domestic and foreign debt: The choice between domestic debt and foreign debt need to be prudent. While, external debt has lower interest rate advantage, however, the risk of foreign exchange fluctuations, unhedged positions and expected rise in interest rates for external debt has resulted in creating larger financials risks for companies. Given these situations, refinancing options should be explored carefully.

Improving operational efficien­cies: In my view, the fundamental step to be driven by Indian corporates is to focus on the business and drive operating and financial efficiencies of business that enhance cash flows from the underlying assets. We have witnessed in the past high-value acquisitions that have faced issues in generating the expected returns and cash flows which has led to debt servicing issues.

Restructuring businesses and divestitures: Restructuring of operations by way of looking to divest non-core assets and “bad assets/acquisitions” is also the need of the hour for Indian corporates. Divestments take time and while it is not easy to decide on divestitures, the fact remains the earlier the decision is taken will always help corporates to address the debt servicing issues and protect the core performing business.

Forex hedging and financial instruments: Forex policies and hedging is key aspect of overseas debt management. There are sophisticated financial instru­ments and hedging mechanics which can protect risks from interest rate and forex volatility but need to be clearly understood and assessed before adopting the structures. In the past, we have witnessed FCCB issues for lot of Indian corporates and lessons need to be learnt in planning for interest rate and forex volatility from start and build those risks in business models.

Renegotiation with bankers: Negotiations with the bankers to restructure debt servicing payments and timing is key and this needs to start early. Key part of this process is high degree of transparency from corporates which provides specific action planned as well as trust to bankers. We have always seen in the past that corporates with high governance standards have always had the support and trust of bankers, inspite of difficult situations.

Private equity funds option: Another aspect to be explored for mid-sized corporates is to explore private equity as a source to refinancing the debt burden. While equity is clearly much more expensive source of fund raise, however, in situations, when debt burden and repayment obligations become high which could potentially lead to distress situations, corporates need to be swift to tap private equity. There are global PE funds who focus on distressed and turn-around situations.

Enhanced due diligence by banks: There is a role for banks in India which also need to tighten “due diligence” on loans and project financing. Given some of the past lessons learnt and debt delinquencies, due diligence becomes important to assess projects and determine exposures. Strengthening the due diligence process and bringing in the aspects of challenging business plans of management may look to be difficult for borrowers, but protects bother lenders and borrowers interest in the long run. Global best practices of due diligence, implementation of compliance of covenants, early identification of non-performing assets need to adopted quickly which would bring in a more robust lending process.

Speed of execution and fast decision making to spot early warning signs: In my view, the inherent part of business growth is risk and it is possible to have “bad assets” which need to be restructured or divested to come out of the debt servicing issues. However, key is fast decision making and speed of execution to restructure which will enable corporates to navigate these issues.

Robust corporate governance standards and trust creation with lenders: Above all, I believe it is high corporate governance, trust creation with the bankers (both Indian and overseas) along with management capabilities to deal with the business that would lead to effectively dealing with the debt issues.

The article appeared in the Financial Chronicle. The article can be found here.