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This paper was prepared while the author was a summer intern in the Asia and Pacific Department in 2003. The author is currently a Ph.D. candidate in economics at the Massachusetts Institute of Technology. I would like to thank David Cowen and Kalpana Kochhar for their guidance and overall support. Special thanks are due to Shawn Cole for his helpful comments.
Observations made for 2001 and 2002 are subject to the caveat that data for these two years are from a smaller sample of firms than for earlier years.
See Chopra et. al. (1995) for a complete description of the macroeconomic and structural reforms in the aftermath of the 1991 crisis.
Among the private limited companies, there is a further subdivision into family-run business group companies and stand-alone companies. Group companies represent 34 percent of the companies in the sample and tend to be more diversified than stand-alone companies.
According to the Global Stock Markets Factbook 2003, India ranked 19th in terms of market capitalization, 17th in terms of total value traded in the stock exchanges, and 2nd in terms of number of listed companies at end–2002. As a whole, India’s large exchanges are considered highly liquid, with only six countries having a higher annual turnover ratio than India at end-2002, which was 165 percent.
In contrast, the share of external finance is less than 40 percent in the United States, the United Kingdom, and Germany. The reliance of Indian corporations on external sources to finance investments is similar to that in Finland, France, and Italy, as pointed out by Cobham et al. (1998).
There are several reasons for the decline in companies’ ability to tap DFIs as a source of funds. The government has drastically reduced DFIs’ access to subsidized funds and deregulated interest rates, which has forced DFIs to compete more directly with other lending institutions. Also, a smaller portion of long-term credit provided by DFIs constitutes directed lending, which benefited the manufacturing sector, although it still may be government guaranteed (Ganesh-Kumar et al., 2002).
Currently, most firms can borrow abroad up to US$50 million through the automatic route. Corporate borrowers may raise long-term financing with maturities of 8 and 16 years up to the equivalent of US$200 million and US$400 million, respectively. Recently, new restrictions have been placed on the use of these funds in addition to limits on investments in the stock market and real estate. Effective November 2003, borrowing in excess of US$50 million is also restricted to financing equipment imports and meeting foreign exchange needs of infrastructure projects.
Comparing India to the United States, the average ICRs in 1996 were 2.5 and 8.0, respectively (Kang, 2001). In the United States, the coverage ratio of companies rated AAA by Standard and Poors was 20.3 and B rated was 2.3 in 1996 (Haksar and Kongsamut, 2002).
First, NPLs of the financial sector include impaired loans to sectors other than the corporate sector and, second, since companies raised debt from sources other than banks, not all impaired liabilities of the corporate sector are owed to banks.
The uptick in 2002 may be biased by a significantly smaller sample size.
Similar differences are observed in other countries between the level of reported NPLs by the financial system and potential NPLs estimated using the EBITDA interest coverage analysis. A study by Goldman Sachs (2000) reveals that for Korea, Taiwan Province of China, and Thailand, their reported NPL ratios for the financial system were 18, 5, and 25 percent, respectively, in 2000, while their potential NPL ratios for the corporate sector were calculated as 37, 16, and 44 percent, respectively.
Profits before depreciation, interest payments, and taxes (PBDIT) was the preferred measure of profits due to a lack of solid understanding of the accounting standards for recording depreciation in the income statements.
There are two types of shares in India: (i) ordinary shares, which have a variable dividend but give voting rights; and (ii) preference shares, which give the holder the right to a fixed dividend but no right to vote. However, the latter are not widely used in India.
For example, the maximum punishment for violating the Companies Act is a fine of no more than Rs. 2,000 (less than US$50) or six months imprisonment or both. If auditors’ signed reports are not in conformity with the law, the maximum penalty is Rs. 1,000. There is anecdotal evidence that “corporates have even offered to make this payment upfront” (Godbole, 2002).
A study by Goswami (2002) of the boards of the top 100 listed private companies reveals that most of the boards are numerically dominated by executive directors or, as Godbole (2002) argues, are packed by retired corporate executives, government bureaucrats, family members and well wishers, who have little say over board matters.
Companies are required to disclose information on the equity shareholdings of individual promoters, financial institutions, foreign institutional investors, foreign holdings, other corporate bodies, top 50 shareholders, and other shareholders.
A sick industrial company is defined as an industrial firm that either (i) has annual accumulated losses greater than or equal to 50 percent of average net worth during four years immediately preceding the financial year; or (ii) has failed to repay its debts within any three consecutive quarters on demand made in writing for repayment by a creditor or creditors.
The Reserve Bank of India and ICICI Bank each tracked a small set of companies for the period 1980–1990. These data are, however, not available to the public at a disaggregated level.
A company is classified as having exited the sample if it does not appear in any subsequent years after the first year it does not appear in the dataset. The drop in the number of companies in the Prowess database in 2001 and especially 2002 is likely due to lags in receiving and processing the necessary information or firms for these two years.