Relaxed regulations resulted in higher lending to firms with poor fundamentals: Economic Survey Report

Regulatory forbearance has resulted in increased lending to firms with poor fundamentals and higher lending to inefficient projects, says the Economic Survey Report 2020-21.

According to it, an extended forbearance or relaxed regulatory regime between 2008-09 and 2014-15 led increased growth of credit to the industrial sector. However, the credit growth failed to translate into a higher investment rate.

India’s Gross Fixed Capital Formation as a share of GDP reduced from 34.7% in 2008 to 28.7% in 2015. Within non-financial firms, the ratio of gross fixed capital addition to additional debt decreased from 56.7% in 2005-2008 to 44.8% in 2012-2015.

“In other words, a lesser proportion of new loans were used for capital asset creation such as buildings, plants, machinery, etc. A larger part of the credit seems to have been used to keep dead loans alive by ever-greening,” says the Economic Survey Report.

In order to make its point, the report cites the example of dirty dozen companies — 12 large firms identified by the RBI that contributed to 25%, or Rs 3.45 lakh crore,  of overall NPAs in 2016-17.

These firms are Bhushan Steel, Bhushan Power, Electrosteel Steels, JP Infra, Era Infra, Amtek Auto, ABG Shipyard, Jyoti Structures, Monnet Ispat, Lanco Infratech, Alok Industries, and Essar Steel.

The Economic Survey Report says that these firms continued to receive credit during the forbearance window even when their financial condition had worsened. New lending to Dirty Dozen firms showed an increasing trend from 2007 to 2014, despite a fall in their average interest coverage from 3.66 in FY2007 to 0.89 in FY2015, says the report.

All these companies were later made to go through the insolvency process. Except for Era Infra, insolvency processes of other 11 cases have been closed either through resolution or through liquidation.

The report further says that aided by poor governance, beneficiary firms under the forbearance regime also seem to have misallocated capital in unviable projects. The total capex projects increased only modestly for firms restructured both during the forbearance regime and before.

However, there was a much higher rise in the number, proportion, and rupee value of stalled projects for restructured firms in the forbearance window. Total stalled projects (as a proportion of all capex projects) increased by 40% (30%) during forbearance, while the same witnessed a decline of 12% (18%) pre-forbearance. In other words, in the pre-forbearance period, firms likely re-initiated stalled projects when injected credit through restructuring, whereas firms in the forbearance window witnessed additional stalling, indicating a possible misuse of increased credit supply.

The report finally says that the legal infrastructure for the recovery of loans needs to be strengthened. The Insolvency and Bankruptcy Code (IBC) has provided the powers to creditors to impose penalties on defaulters. However, it points out that the judicial infrastructure for the implementation of IBC – comprised of Debt recovery tribunals, National Company Law Tribunals, and the appellate tribunals must be strengthened substantially.