Adani Episode Illuminates Several ‘Weak’ Links, Highlights Challenges

Extrapolating the Adani trouble to the economy is fear mongering

India is resilient. The economy is clearly on a very strong growth path. India ranks better in terms of corporate governance metrics compared to most emerging markets. Governance standards of larger Indian companies are improving.

A majority of the top 500 listed firms have real assets, paying customers, and ‘good’ governance track records. Most amongst them are growing, making profits, paying taxes, and adding stakeholder value. They are well regulated, ‘measured’ by the customers for quality and price. The books are audited and the business models tested by competitive forces. Their performance is scrutinised by legions of funds and other shareholders, every day. There is no manipulation, no fraud here.

The MSMEs and ‘others’ in the value chain, contribute over a third to the GDP. They pay taxes, run businesses, create jobs. Most are not leveraged. They are the growth engines.

The equally important and relevant issue of the ‘collateral’ damage is clearly overblown. It is largely contained. The domestic banks are not vulnerable. The exposure to the Adani group is not ‘significant’, and ‘protected’ by the underlying assets, operating cash flows and projects ‘under’ implementation. Exposure to the pledged shares has several ‘safety’ clauses.

*Economy plagued with a weak infrastructure. Missing link in the growth story.

The Adani episode is also a pointer to the bigger, more fundamental, more structural challenge of a debilitating ecosystem, particularly in the infrastructure sector. And as a result, there are not many entrepreneurs with the means, the risk appetite, scale, and execution ability to take on the onerous job of building and providing infrastructure. This requires a dozen infrastructure providers. India will invest $1.5 trillion in infrastructure over the next decade. The government of the day must put together a working model, a robust framework where the honest businesses are both ‘eager and capable’ of building India and its infrastructure.

The government’s own record of ‘building’ infrastructure is dismal. It has tried several models including the PPP and has failed more often than not. The record of the private sector, barring a handful, has been less illustrious.

*India is a difficult place to build in

Most have perished, some for ‘ambition beyond ability’, others because of wrong intent, but mostly because it’s impossible to execute projects of mass proportion under the difficult and decremental ecosystem. The collateral damage of failure is many (loan defaults, cost overruns, incomplete and delayed projects etc.) and visible.

Adani and other infrastructure builders are always at the mercy of the market. The business is a capital guzzler. The cost of capital is prohibitive; returns are abysmal (in low single digits) if any. Infrastructure cannot be built by borrowing at ‘bank’ rates.

Part of the high valuation of the Adani’s group is due to its unique position in the energy, infrastructure, and logistics sectors. Some of it is because the market credits the group to both ‘build and scale’, something that very few have not been able to do. However, and equally, there is no denying that a substantial part of the valuation is driven by the ‘control’ that the family and the other entities have on the listed companies.

*Deadly cocktail of ambition, opaqueness, and control. Ends badly

This is also an opportunity for the corporate sector to think through, question their methods and practices.

The Adani group like many other family-owned groups is both complex and opaque. It’s common to have a maze of tens of subsidiaries, ‘step downs’ and related entities, injecting the complexity, and adding to the opaqueness. The goal is to control. We need to design and develop a regulatory framework to address these challenges. Today we have none. The government has a role in ensuring compliance with regulations and standards.

As an example, while SEBI mandates a minimum float, it lacks the tooth to bite. Mauritius with a GDP of $12 billion, houses over 6,000 companies. It’s easy to see what’s happening there and how entities are capitalising on the loopholes.

The Adani group's situation also highlights the importance of corporate governance and the need for transparency in their operations, honesty in their dealings and responsibility in their financial reporting. Stakeholders and society at large expect it. They must now demand. Companies should focus on building a solid foundation of good practices to protect their long-term financial stability and maintain the trust of their stakeholders.

Similarly, the meltdown highlights the myopic nature of the market participants, who are focused on narrow issue like the long-term gains tax, completely ignoring the real and bigger challenges of the investing community. They invest in irresponsible manner, sidestep well laid practices, ignore signals, and yet expect the regulator to protect them when things go south.

*Regulator: inertia & indifference. Not corruption & cronyism

The government must strike a judicious balance between promoting growth, ensuring stability and integrity of the financial system. India needs to identify an infrastructure financing model where there is a long-term, low interest availability of capital. The RBI must consider the implications of its monetary policies on the capital structure of companies and prevent the buildup of systemic risk in the financial system. Low-interest rates encourage companies to borrow more (than needed). Over-leveraging makes them vulnerable to economic shocks and market volatility. The long-term consequence of high leverage rather than equity to fund growth is dangerous; it ends badly.

*Several signals, if we ignore the noise

Several lessons can be salvaged from the episode. There are lessons from history as well. Demonising an individual doesn’t help reform the system.

The Adani episode has illuminated the ‘weakest’ link in India’s growth story, provided us an opportunity to reform and to largely fix the challenges and strengthen those weak links.

Our political fraternity will do well to identify models and frameworks that will enhance India’s growth and competitiveness. The action as a result of this crisis will have far-reaching implications for the economy.