I wrote this blog sometime in the last week August. This is a sequel to that blog. A few things good and bad have happened in between and that made me write this blog and rather quicker than I would have. Even if these would not have not happened, I would have probably written this blog as part of my- in my friend’s words – mental mas$#%bation. Here are the news items.
One: We are trying to raise some money for two micro finance companies in Madurai through Public Sector Banks. There was a scheduled meeting with the regional decision makers on 16th Sep, 2019. Bank called us on 11th Sep and postponed the meeting to 26th Sep 2019. Reason was this. Officials from Ministry of Finance are coming down to have discussion with all bankers in Madurai Districts. This is happening in various districts, the banker said. He also advised us not to come to Madurai during that week since most of the senior bankers would not be available. Finance Ministry is keeping its ear close to the earth. This is heartening.
Two: On 20th Sep 2019, the Finance Minister substantially reduced the Income Tax and MAT rates. Corporates are quite happy. The corporate taxation is 21% of the government’s revenue. The whole world believes this will have positive ramifications. Some believe GDP will grow @ 8% from Q4 of financial year 2019 – 2020. My best wisher to them. This definitely puts money in the hands of corporates. If they have a project, they can re-invest. Generally, there will be marginal inflationary pressure and the government is compelled to bridge the gap by PSU sale and trust, for our own sake, that our economy will rebound. Our best wishes to the Finance Ministry. However, this measure is not going to make any impact on marginalised sections of economic activity – Real estate infra-structure and MSME. While tax reduction is good, the country is crying for more fundamental reforms. I hope stronger measures will be rolled out by the Finance Minister in areas such as land acquisition, labour laws, real estate, infra and MSME reforms.
Three: What really shook me out of inertia was an article in the Business Standards titled “Arvind to raise Rs.490 crores in long-term loans, restrict capital expenditure”. About it later.
Four: Then came the more welcome announcement on 23rd Sep 2019 to the effect that stressed MSME loans will not be declared as NPA till 31st March 2020. This is a welcome start. However, dilapidated definition of MSME was discussed in Part I of this blog series. This definition largely restricts the eligible NPAs that can be postponed. The Finance Minister should extend it to all companies with turnover less than Rs.1000 p.a. At the minimum, to all companies that have total bank debt of Rs.100 crores or below.
Five: On 24th Sept 2019 there was another news item which said Bharat Petroleum and Container Corporation will be privatised before 31st March 2020. Apart from dole outs, the Finance Minister is having an eye on fiscal deficit too. She is working extremely hard and taking bold decisions. I hope the decisions yield necessary results. Even if she fails, God forbid, one cannot blame her for not trying enough.
The measures may give immediate fillip. GDP may still show the jobless progress it has been showing for a decade now. Present actions still are not watershed revolutions. They are not disruptive enough. Even reduction in tax rates cannot bring about fundamental change.
Fundamental reforms should address the ills of the nation. Our agricultural productivity is among the lowest. There has to be policy framework to improve the agricultural productivity.
Land acquisition policy has not been in place without which foreign manufacturing companies may not look at India favourably. Lacs of crores of infra-structure projects are also in jeopardy because of lack of coherent land acquisition policy. Our labour laws are far cutaway from the reality, and they don’t reflect the times. There is no way on earth any company can be compliant with respect to labour laws. So proper manufacture friendly labour laws should be in place and the employment generators – reality, infra and MSME – should be brought back on track.
All these require paradigm shift in the way we do things right now. They require huge will from the government side. All these have multiple repercussions and have long gestation. Yet they have to be done sooner than later. This government has the requisite mandate to do just that.
Coming back to the announcement made by Mrs. Nirmala Sitharaman that stressed MSME loans will not be declared as NPA till 31st March 2020. This is the single most welcome statement made by the Finance Minister in her weekly announcements. Commercial lending to MSME (Debt exposure less than Rs.100 crores). Is over Rs.20,00,000 crores. NPA profile of MSME is actually much lower compared to corporates. So far about 10% of these 20 lacs + crores would have been declared NPA. I dare say under basel IV at.least 60% of these debts are NPAs. One may think I am out of my mind. But the fact that Mrs. Nirmala Sitharaman has announced the postponement and multi-level considerations happening at grass root levels indicate that the government is aware of this problem. If they are aware, I am sure they will be aware of the root cause of the problem too – unreliable Balance Sheet in Indian companies. This blog contains detailed methodology in which accounts were fabricated by Indian industry. Let us just say gaming the system is how MSME has survived for this long.
This problem is deep-rooted. The announcement by Arvind Ltd., is a case point.
According to Business Standards dated 23rd September 2019, Arvind Ltd., is planning to raise long term credit worth Rs.490 crores to replace loans as part of plans to improve its financial profile. The words are verbatim reproduction of the Business Standards report. Here the operative phrase is ‘plans to improve its financial profile’. In other words, it is an admission that the financial profile of the company is less than desirable.
Arvind Ltd., sales is around Rs.6,500 crores with a reported net profit of about Rs.200 crores. They have a short-term loan of about Rs.1,500 crores for a net working capital of about Rs.1,500 crores. This means that the company’s capital in working capital cycle is nil and is entirely financed by banks and financial institutions. It is this situation the company seeks to rectify by taking long-term loans and closing working capital loans.
While this is a commendable step, the question that arises is, why has it happened in the first place?
In the previous part of this series, I thought Balance Sheet of companies with turnover less than Rs.1,000 crores is a suspect. Maybe we can assume that even Balance Sheet of companies that have a turnover of one Billion Dollars require correction.
This is hardly surprising. Arvind started its journey in License-Quota-Raj. Only people with license could produce anything at all and the quota based on demand forecast ensured profits to license holders. Since quota is fixed, maximising profit is possible only by producing and selling more than the quota. i.e. outside the books of accounts.
We have come a long way from licenses of the 60’s and 70’s – to the extent of running a parallel cash economy.
The point of writing about Arvind is not to say they have done anything wrong. The point is the entire ecosystem operated in such a way that manipulating the systems and set norms were considered as basic necessities and manipulations have never been exceptions.
Another example – a traditional group from Chennai manufacturers automobile parts for various automobile manufacturers. Their normal turnover is about Rs.30 crores per month. They enjoy a working capital limit of Rs.80 crores with banks. Due to the automobile recession their turnover has come down by nearly 50%. Even after the next three months, we can reasonably assume the utilised limit will continue to be Rs.80 crores or closer to Rs.80 crores and not half of the limit as it should be, Why? Nothing in the Books of Accounts of Indian companies can be accepted at face value.
When it comes to MSMEs with a loan exposure of less than Rs.100 crores, we can be reasonably sure that the Balance Sheet is nothing but manufactured numbers to meet the working capital and term loan norms of banks.
Have a closer look at the short-term bank loans in the MSME Balance Sheet. if it is closer to 25% of the turnover of the company, we have to be careful with the Balance Sheet numbers. In these Balance Sheets Inventory and Receivables will be 25-30% each and paybles will be 10-15% If you see a Balance Sheet Like that you can assume, you may be looking at a potential NPA under Basel IV norms. I believe Government is aware. That is why they have postponed the reporting by six months.
People often wonder why a company rated ‘A’ by rating agencies such as Crisil becomes ‘D’ (Defaulter) in a next month. It is just that financial bubble called working capital loans has burst.
This is the scenario in which we operate. There are many MSME entrepreneurs who do not know whether they make profit or loss, if so, how much. It is the same for companies in trouble, companies just about floating, and companies which are prosperous. Loss making companies do not know the extent of their loss and profit making companies do not know the extent of their profit.
We are basing these Balance Sheet numbers to arrive at the steps to be taken. We are assuming the next disruptive reform is soon going to come based on these numbers. In an ideal scenario demonetisation and GST would have been a grand success. Cleaning the Balance Sheet should have been the first major disruptive policy of the government. Unfortunately, this is a holy cow and nobody will touch it.
Even now it is not too late. People who have hidden income in the Balance Sheet by bogus expenditure should be encouraged to clean it up and take it into retained earnings. Most of the entrepreneurs who have loans less than Rs.100 crores will be more than happy to clean up the Balance Sheet if there is no penal action involved. It will be a great relief to the entrepreneurs, and they will turn real wealth creators for the country.
This does not require additional cash, since the loan has already been given. Loan will only be re-stated. This will save the banking sector by not having to declare another Rs.15,00,000 crores as NPA (my guess). Of course, there will be a few tax collections issues and the method of treatment of adjustment in the books of accounts so as to reflect the true and fair view. I will write my next blog on how I think. re-statement of Balance Sheet can be achieved.
To be continued……..