All of us know Kingfisher Airlines borrowed more than they were capable of repaying comfortably and their game was up when their cash flows were not sufficient enough to service their debt. Once a company is identified as defaulter, nobody would lend them further and they cannot continue their business. And if they do not have sufficient assets to cover their debt, you know who will have to write it off – their lenders, banks in this case.
|5 year stock performance of JPA; Source: Google Finance|
Do you ask why now, when Indian economy seem to be improving? Here is my reasoning.
RBI had cut repo rate by 75 bps so far in 2015. But industry does not seem to be happy. As further rate cut hopes are put to rest and with a weak monsoon warning raising the fear of demand/consumption to come down, there was a blood bath in the stock markets. Indices were already 15-20% down from their all-time highs. But it is few sectors and stocks which lost significantly.
Though economic recovery is weak, lower interest rates (however small they are) would have reduced the capital costs burden. But it does not seem to be sufficient for those companies which had big debts on their balance sheets. If you had read this article on Value Research last week (https://www.valueresearchonline.com/story/h2_storyview.asp?str=28001), you would have known stock markets behavior this week was expected. It is not uncommon for infra companies to have higher debts but what happened with these companies in the list are loans grew at a higher pace than their top line and profits. Too much leverage would have been digested in an economy growing in double digits but now they are sinking with the debt load and there is not much hope let for them.
So this puts forward one important aspect. Even if RBI reduces rates further by 100 bps, these companies would still struggle to service their debts. And when that hope (of reducing rates) vanishes along with headwinds to economy (weak monsoon) coming to surface, it acts as a trigger for the sell-off. If and when these companies start defaulting on their loans, they cannot get fresh loans and their business continuity will be at risk.
When some of these companies sink, what will happen to their lenders (banks)? Now you know why Bank Nifty saw all of its components in red on the day RBI announced a rate cut, despite capital costs coming down for Banks and borrowers eventually.