After the Hindenburg hit, as the stock values of the Adani group companies unwound from the clearly unwarranted highs to which they had risen, one concern was the impact this meltdown would have on financial investors exposed to Adani firms.
Special concern was expressed on the impact it would have on public sector banks and financial institutions such as Life Insurance Corporation (LIC) of India. They had clearly contributed significantly both to the spectacular expansion of the assets of the group and, implicitly, to the huge rise in the value of the equity it had issued and leveraged to finance those investments.
This concern derived from the many questions that arose given the scale and nature of the exposure of these institutions to companies that had seen an extraordinary collapse in their share values.
First, how significantly would the loss resulting from the exposure to the Adani group affect the profitability and viability of these public financial institutions, with attendant systemic effects on the rest of the financial system and the economy?
Second, to what extent would that loss affect the financial position of the savers and investors from whom the capital of these financial institutions had been mobilised, in the form of deposits, premiums or investments in equity or debt instruments?
Finally, to what extent were the losses that have been incurred and transmitted to the public financial institutions the result of investment behaviour that should have been avoided?
Inasmuch as the capital mobilised by public financial institutions derives from the savings of ordinary citizens held as deposits or investments, or paid as premiums to insure against risks, there is a requirement that those managing these assets have a fiduciary responsibility and regulators must ensure that they do not behave in ways that endanger the safety of the savings of citizens. If those responsibilities had been ignored or sidestepped in the Adani case, then it is quite possible that similar “errors” could be made in other instances with consequences that may not be easily managed.
LIC’s exposure
The fear of losses arises because the total value of LIC’s holding in five Adani companies, namely Adani Enterprises (4.23 per cent as of December 2022), Adani Total Gas (5.96 per cent), Adani Green Energy (1.28 per cent), Adani Transmission (3.65 per cent) and Adani Ports (9.14 per cent), reportedly fell from Rs.72,194 crore in January 2023 to Rs.28,862 crore on February 23, 2023.
It is true that much of this loss is notional, reflecting the gains in Adani stocks that could not be sustained. But the February 23 valuation was 11 per cent below the sum of Rs.30,217 crore paid by LIC to purchase these shares. Even if it is true that this loss would not affect LIC much, since its total exposure to the Adani group estimated at book value is just 0.975 per cent of its assets under management, it presumably will reflect in the bonuses paid to investors.
Moreover, there is no guarantee that the decline in the value of Adani group stocks will remain near their February 23 levels.
Exposure to debt
As is now widely reported, the group companies’ exposure to debt was extremely high, and access to this large volume of debt was ensured by pledging stocks as collateral to obtain loans. The value of that collateral was estimated at their previous (inflated) prices.
With much of that value having evaporated after the Hindenburg accusations, the Adani group would be under pressure to offer alternative guarantees as well as to meet loan commitments when they fall due.
Rolling over existing loans or substituting old loans with new ones is unlikely to be an option, given the high debt exposure and the absence of high value of collateral that stocks with inflated prices offered.
The group companies’ decision to make early repayments on debt subject to margin calls or debt nearing maturity, as well as to drop acquisition and expansion plans to curtail expenditure, is clearly an effort to limit damage. That damage is already reflected in the company’s debt trading at near distress levels. In the circumstance, further declines in share values are likely, with attendant adverse implications for the assets of clients and shareholders of LIC.
The value of LIC’s shares has also been falling from a high of Rs.739.95 on January 3, 2023, to Rs.570.35 on February 28, a loss of close to 23 per cent over that two-month period. The share is now valued 40 per cent below its initial public offering listing price of Rs.949 a share on May 17, 2022. According to media reports, compared with a decline of 0.19 per cent in the BSE Sensex during the month ended February 27, LIC’s share price fell by 14 per cent. LIC’s shareholders are definitely taking a hit.
And then there is the danger that if things go awry, Adani group companies may default on debt service payments—a development that would certainly not be unprecedented, given the recent record of leading groups in India. That would only increase the losses incurred by LIC and affect both clients and shareholders. According to M.R. Kumar, Chairman of LIC, of the corporation’s Rs.30,000-plus crore exposure to the Adani group, around Rs.6,000 crore is in debt.
Justifying an exposure of this magnitude is indeed difficult, although LIC has stated that the credit rating of all Adani debt securities held by it was AA, making the investment compliant with norms set by the Insurance Regulatory and Development Authority of India. However, that applies only to debt.
There is no doubt that the growth of the Adani empire was extremely rapid and focussed on risky infrastructural areas. Moreover, there is clear evidence that the growth was fuelled by large volumes of borrowing. And concerns were being expressed that the sharp rise in stock price valuations of the group, which helped access those large volumes of debt, reflected price-to-earnings ratios that were abnormally high for any industry, let alone for infrastructural projects.
There was no reason why the exposure of public financial institutions such as LIC to the Adani group should have kept pace with that growth.
Red flags
What is more, even before Hindenburg declared that these high stock prices were the result of manipulation (which Adani denies), there were many commentators, including seasoned ones from the Bloomberg stable, who were sceptical not just about the valuation of these companies but also about the true nature and independence of the companies that had bought into the equity of the Adani firms.
They made persuasive arguments that these companies are both insubstantial and not altogether independent of the promoters and that, therefore, the shares held by the promoters and related companies in the Adani group exceeded the 75 per cent ceiling set by the Securities and Exchange Board of India for listed companies.
These assessments had raised enough red flags for the LIC management to have chosen to maintain a respectable distance (in the form of minimal exposure) from the Adani group. It did not.
That is striking because the management’s behaviour in this instance seems to have undermined the very raison d’etre of LIC, which was created in 1956 through the nationalisation and consolidation of 245 private insurance companies. Among the objectives of nationalisation, the protection of the interests of insurance clients was dominant.
It was felt that, while it was important to encourage ordinary citizens to provide for eventualities, the adverse consequences of which need to be insured against, those sums must be protected from misuse in speculative investments by private operators focusing solely on quick profits.
This is important given the nature of the insurance industry, which delivers “products” that are promises to compensate the insured with payments when specified contingencies arise. To insulate themselves fully or partially from risks, including events that leave dependents uncared for in case of death, insured clients make prior contributions with the hope that promises will be redeemed when circumstances warranted.
These funds are deployed by the insurer in investments. Given the objects of the contract with the insured, those investments, while yielding enough to allow the “promises” to be redeemed when necessary, should not be in areas where the risk of loss is high, as the insured can be left without the promised support when the situation demands.
Investments and returns
The profitability of investments and the returns yielded from them determine the ability of the insurer to meet those promises. Ensuring those returns without excessive exposure to risk is crucial. Prior to nationalisation, it was felt that private players were privileging profits over safety at the expense of the insured. Hence the decision to take over ownership of the insurance companies and consolidate them to benefit from scale and scope.
LIC’s actions in the case of the Adani group suggest that it deviated from the original intent that motivated nationalisation. This only gives more cause for concern for clients and investors because recent actions may not be a one-off deviation but a change in behaviour. In such a case, the damage need not be restricted to a small proportion of assets under management.
What the behaviour of LIC, and of nationalised banks such as State Bank of India, makes clear in this instance is that public ownership alone does not ensure due diligence and appropriate conduct. Although the government divested a small percentage of its shares in LIC in 2022, it is still the dominant owner.
What public financial institutions do is, in the final analysis, influenced by what an incumbent government representing the state, which is the owner of these institutions, wants it to do. In this case, the incumbent government, in its enthusiasm to back selected “national champions”, may be putting institutions such as LIC and the public sector banks at risk.
C.P. Chandrasekhar taught for more than three decades at the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi. He is currently Senior Research Fellow at the Political Economy Research Institute, University of Massachusetts Amherst, US.
The Crux
- The concern expressed on impact of the Adani episode on public sector banks and institutions such as LIC.
- Those managing public assets must ensure that they do not endanger the safety of the savings of citizens.
- Total value of LIC’s holding in five Adani companies fell from Rs.72,194 crore in January 2023 to Rs.28,862 crore on February 23.
- The notional loss may reflect in bonuses paid to investors.
- There is no guarantee that Adani group stocks will not fall further.
- There is the danger that if things go awry, Adani group companies may default on debt service payments.
- Of LIC’s Rs.30,000-plus crore exposure to Adani group, around Rs.6,000 crore is in debt.
- LIC’s actions suggest it deviated from the original intent that motivated nationalisation.
