Ind-Ra: Pressure on Corporate Credit Quality to Persist in FY17

In the absence of external shocks, corporate profitability (EBITDA) in FY17 is likely to grow only 7%-9% yoy in FY17. The sluggish EBITDA growth would keep the aggregate leverage levels of the top 500 corporate borrowers high, says India Ratings and Research (Ind-Ra). The agency expects aggregate leverage for FY17 to remain at FY15 levels given the current low investment levels and a stable working capital position. However, the fragile recovery which would allow corporates to deleverage over the medium term to FY11 levels could be further delayed in case of external shocks.

Recovery Challenged by External Shocks: External risks such as the slowdown in China that has had a significant bearing on commodities as well as currency markets could impact the fragile recovery in the credit profile of corporates during FY17. The direct impact of a devaluation of the Chinese currency would be in the form of higher imports and increased competition in exports whereas the second order impact through emerging market risk aversion could be of a much higher magnitude given the high leverage in the system. While India will remain attractive relative to other emerging countries given its macroeconomic stability, it would not be able to insulate itself from evolving global risks.

Risk Aversion by Banks: The concentration of debt in sectors such as infrastructure (power), construction, real estate, steel, non-ferrous metals, is likely to demarcate the survivors from the laggards (having a weak credit profile) in FY17. Banks have been rationing credit due to capital constraints given their existing burden of impaired assets and lack of certainty of full and timely recapitalisation. Ind-Ra expects solvent entities with interest cover in the range of 1x-1.5x (10% of total debt or INR3.3trn) and which have limited cash / liquidity to potentially be at risk to add to the list of stressed assets (interest coverage less than 1x) during FY17.

Lukewarm Nominal GDP Restricts Growth: Ind-Ra expects commodity users and consumption-linked sectors such as auto, auto components, and consumer non-durables to see marginal improvements, though gains will be capped by the lower nominal GDP growth (FY16: estimated 8.6%, FY15: 10.8%), in relation to historical standards. Also, entities in the services sector would continue outperforming those in the manufacturing space. Nominal GDP growth of 11% as estimated by the government of India, if achieved, could provide some impetus to companies having a strong financial profile; however, nominal growth has taken a hit across all segments of the economy during FY16 and a significant pick up in public investments and consumption would be required to achieve the projected nominal GDP growth.

Credit Profile Unlikely to Improve to FY11 Levels: Leverage for FY17 will remain close to 4.74x (similar to FY15 level) and the process of deleveraging to FY11 levels (3x) will take at least three years, particularly for the companies operating in commodity-linked and capital-intensive sectors. Debt levels have continued to grow at a rate (FY15: 6.3%, FY14: 21%) faster than the growth in operating profits (2.3%, 13.9%). 62% of the total debt for FY14 and FY15 among these entities belonged to the corporates which were highly levered (leverage above 4x). At FYE15, about 25% of the total debt (INR8.1trn) of the top 500 listed borrowers was with entities with interest coverage below 1x.

Low Capex to Restrict Borrowing and Growth: Ind-Ra does not expect a significant uptick in private capex until FY19 on weaker credit conditions. Although further deterioration of the credit profile of corporates may be checked due to lower debt on a low capex activity, a pickup in operating income could also be restricted thus delaying deleveraging. Private sector capex declined 6.9% yoy in FY15 to INR2.4trn, the highest fall observed in the last five years and this is likely to have continued in FY16.

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