Beware the bankrupt chaebols

S. Vaidya Nathan

IN THE past week, the flagship of South Korea's Daewoo group -- Daewoo Motors -- was declared bankrupt.

Hyundai Engineering escaped this fate as creditors gave the company time till the end of the year after it promised rigorous reforms. The troubles experienced by these two companies especially, Daewoo, is a culmination of woes that started during the 1997 South-East Asian crises.

Daewoo Motors had been on a lifeline the last year or so with a rescheduling of its debt and a credit line of $2 billion. It now turns out that good money had been thrown after bad. Even if some arrangement is worked out, the creditors are expected to lose 75 per cent of the $16 billion advanced to the company.

Along with Samsung and a couple of others, these chaebols virtually had a stranglehold on the Korean financial system. Thus, the financial system and the state itself had much vested interest in the survival and growth of these conglomerates. While the government has at long last adopted a firm approach, it, and the people may end up picking up the bill.

The Daewoo and Hyundai stories have a relevance for India. A few business groups have pursued similar strategies. Reliance, Essar, Jindal and Ispat have such a stranglehold on the financial institutions -- IDBI, ICICI and IFCI -- that their futures more or less depend on how these groups perform.

And just like the Korean conglomerates, the Desi business groups, and others on a smaller scale, have forayed into diverse highly capital-intensive businesses. Most have been delivering poor returns on equity over time and may well find themselves in a bind if they have to raise fresh equity.

The strength of business groups has been in their ability to swing policy decisions in their favour; that is, in areas where there is policy ad hocism. Most of these business groups have, thus, manoeuvred into key industries such as oil, power, finance, insurance, telecom and infotech (being the latest craze for all those missed the bus) where the stakes are high for the economy as a whole. As a consequence, their ability to place the state in a bind is high. Similar to the way in which the South Korean conglomerates operated. This, the high intra-group activity and the opacity in the balance-sheet -- have now created problems for the companies themselves, the creditors and the Government.

Perhaps the most important message of the Daewoo fiasco is that the name and size of a business group matter little once the problem cycle begins. To avoid such a denouement in India, the lenders (banks and financial institutions) must be extremely prudent in decisions vis-a-vis major business groups and check out on a company's ability to raise equity independently (this facet is a good window to the market view of a company/business group). It is not as if lenders are not aware of these issues but extranneous pressures have coloured their decisions.

The Government, for its part, also needs to keep the policy framework transparent and not tinker with it to suit the aspirations of certain business groups, as has been the case in the oil sector over the last couple of years. These, coupled with a competitive business environment, can minimise the chances of problems of the Daewoo kind.

There have already been problems with Essar and Spic groups. To avoid bigger ones, the South Korean experience needs to be treated as a warning signal and not dismissed as something that would not happen in Corporate India.

Till the South-East Asian crisis broke out in South Korea, there was not even a clear picture of the domestic and foreign debt exposures of the major groups. But as numbers came out they showed that figures reported earlier had hardly reflected the truth. To get a good picture of how a business group is faring, the regulatory framework must ensure that group-level disclosures are of a high order, individually for the various companies and at the consolidated level too. Proper checks and balances must be in place to also ensure that the disclosures are in line with reality so that nasty surprises are not sprung on the various stakeholders.