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The end of the 'class struggle'

Tamal Bandyopadhyay | February 06, 2003

Attendance at the Essar Steel board meet last week was unusually high. Most of the directors of this ailing steel unit were present, but here's the surprise.

Despite the health of the company they head, the directors were laughing and animated. Essar Steel had found something to be happy about at last -- a restructuring package put together by banks and financial institutions.

The package was formalised at the headquarters of the Industrial Development Bank of India on January 24. It covered liabilities worth Rs 20,000 crore (Rs 200 billion) of three steel companies -- Essar Steel, Jindal Vijayanagar Steel and Ispat Industries. That brought to an end -- to the month -- a four-year old controversy that began in another IDBI office.

On January 7, 1999, the first blue-print of the steel rescue package was drafted at IDBI's Delhi office under the direction of a former advisor to the finance minister. This raised a storm of protest in the financial world.

The banks and financial institutions, it was believed at the time, had been arm-twisted into preparing a Rs 2,130-crore (Rs 21.3 billion) revival package for 14 steel companies in which Rs 24,500 crore (Rs 245 billion) had already been invested.

As a result, IDBI postponed its steel sub-committee meeting as well as its board meeting several times. Of course, it was not explicitly acknowledged that the upsurge of protest was the cause of the postponements. The official reason given was "lack of quorum" for one  meeting and that "the board needed more time to study the proposals" for another.

Not surprisingly, that package never materialised. This time, too, the finance ministry played an active role in preparing the rescue act. In fact, the recast package, cleared by the corporate debt restructuring committee, was meticulously drafted in North Block in the first week of January.

Despite this, there was no protest in political circles. The reason: the January 1999 package was largely considered a bail-out for Essar Steel, which was then on the verge of defaulting on its Floating Rate Note issue.

The January 2003 package covers three steel companies that are crumbling under an interest rate burden that is far higher than current market realities.

Now that the recast is being ratified by the boards of the lenders as well as the borrowers, calculations are being worked out on the kind of "hair-cut" the banks and financial institutions have taken.

Have the lenders only waived interest on accumulated unpaid interests and penal interest for delay in clearing dues, in which case the sacrifice would come to roughly Rs 60 crore (Rs 600 million)? Or have they drastically cut interest rates, which would entail a bill of Rs 1,400 crore (Rs 14 billion).

After all, the weighted average cost of rupee interest has come down from 16.7 per cent to 14 per cent. Besides, 40 per cent of the rupee loans have been converted into dollar loans carrying an interest of only 8 per cent.

The debate has been endless. It is true that if the banks and institutions had not slashed interest rates, they would have got much a higher return on their funds.

But the lenders have reduced the cost of their liabilities by replacing the high-cost debt with fresh low-cost borrowings, so they are not losing much in terms of spread (the difference between interest income and interest outgo).

Besides, is there anybody who could have guaranteed that original return? If the borrowers crumble under the high interest burden and are in no position to service the debt, what's the point in charging high interest rates? A lower but serviceable interest rate is better than one that is higher but not realisable.

Take a look at the basic components of the package for the three steel companies:

  • The promoters will be required to write down the equity by 40 per cent and convert part of the debt into equity so that the lenders' stake in each company equals that of the promoters.
  • The promoters are  also required to provide personal as well as corporate guarantees.
  • A trust and retention account will be opened into which all the revenues of these steel companies will flow to ensure the repayment of debt.

The package sends a clear signal that the lenders are not ready to play  martyr. Their message is that they can, at best, create a platform and it is up to the borrowers to take up the challenge of getting on with business.

More importantly, the recast has made it clear that the banks and institutions are ready to shed their Shylock approach of allowing borrowers to default. Instead, they are taking the more pragmatic approach of negotiating repayment and using such sticks as the securitisation bill to bring the truant borrowers to the discussion table and settle accounts.

There is no doubt that this is the best way to tackle the stock of stress assets with banks and institutions since provisioning for such huge sticky loans would put even the big boys deep in the red.

To be sure, there are virtually no other options. The banks and institutions could take over the assets of defaulters but is there market to sell these assets?  Probably not. Do the lenders have the expertise to run these companies? Again, unlikely.

One Malavika Steel case made it clear that Indian lenders are best at managing money and not running a factory. That is why it is better to aggressively pursue such negotiated settlements in steel, cement, petrochemicals and textiles where sacrifices on both sides and close monitoring by the lenders of the restructuring package can save the outfits as well as recover the funds from the quicksand of non-performance.

It is entirely possible that there could be another round of recast for the three steel companies down the years since the 14 per cent revised interest rate for rupee loans and 8 per cent rate for foreign loans are out of sync with market realities.

Besides, the boom for the steel industry will not last forever and once the cycle changes, they will find it difficult to even service the restructured debt.

But at least a beginning has been made. Both the borrowers and the lenders have realised that it is foolish to fight and inflict wounds on each other. The steel package recast suggests that we are in for a major shift in lender-borrower relationships.

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