India’s Lehman genie is out of the bottle yet again

First, it was the IL&FS Group that ran out of money. Now that the bankrupt Indian infrastructure lender-operator has been sequestered from creditors, the country’s securitisation industry is on borrowed time.
It all began with S&P Global’s Indian affiliate, Crisil, downgrading Jharkhand Road Projects Implementation Co.’s annuity-backed bonds to D after it skipped interest and principal payments. It’s a strategic default on an instrument rated AA just last week. The borrower had money. It reneged on the obligation because the IL&FS parent and 348 group companies have been allowed by the country’s bankruptcy tribunal to block creditors while a government-appointed board sorts out the $12.8 billion debt load.
What makes Jharkhand’s default disturbing is that investors believed its securitised debt would be unaffected by the parent’s bankruptcy. These bonds were legally backed by annuity income from the Indian state of Jharkhand. That assurance was the basic premise on which they invested in the structured debt obligation in the first place.
Most gray market lenders don’t finance roads and bridges, but advance money raised from deposit-taking banks and money-market mutual funds to small businesses and micro-finance borrowers, as well as against home and vehicle ownership. Their wholesale borrowing costs spiked in the aftermath of IL&FS defaults.
Since their assets are mostly doing just fine, and certainly a lot better than conventional banks’ big-ticket advances to India Inc., the shadow financiers started to package small loans for sale to the likes of State Bank of India. The whole point of the exercise was to create pooled assets that would survive the originator’s bankruptcy. Jharkhand’s default has removed that comfort. Last quarter’s record $3.7 billion monthly run rate of Indian securitisation deals is suddenly at risk.
When IL&FS started to blow up in September, I warned that this was India’s mini-Lehman moment. A fairly swift rescue by the authorities managed to contain a full-blown crisis of confidence. But the Jharkhand default has put the genie of mistrust out of the bottle again.
An immediate order to IL&FS’s new board to honour securitised debt is the need of the hour. Otherwise, India’s funding markets could see a repeat of last autumn’s freeze.
The collapse of IL&FS has put a question mark on India’s model of infrastructure financing. India needs hundreds of billions of dollars for roads, bridges and power plants. It will be hard to raise that money if ring-fenced investments go from AA one week to D the next.
—Bloomberg

Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.