Reserve Bank of India Governor Raghuram Rajan is correct in flagging concerns about the high level of corporate debt and India Inc's ability to service it, due to declining growth and profitability. This could result in more pain for banks, as bad loans could rise further.
Nearly a fifth of corporate India's debt is in troubled waters. These companies either reported operating losses in the last financial year or their operating profit is insufficient to cover their annual interest burden.
In all, these 67 companies had a total debt of Rs 5.65 lakh crore on their balance sheets at the end of 2014-15, accounting for a fifth of all borrowings by the country's top 441 indebted non-financial companies. The net worth has turned negative for many of these companies, making them financially insolvent technically.
The number of companies with insufficient operating profits to service the interest burden (interest coverage ratio of less than 1) increased to 67 by the end of 2014-15 from 49 in the previous year, 29 three years ago and only 16 companies at the end of 2009-10.
The analysis is based on the indebted companies from the common sample of BSE 500, BSE Mid-cap and BSE Small-cap index. Excluding zero-debt companies, the sample includes 441 non-financial companies.
At the end of 2014-15, the companies in the sample were sitting on a total gross debt of Rs 28.5 lakh crore, accounting for 98.1 per cent of the total gross debt of all 654 non-financial companies in the universe. In comparison, the indebted companies accounted for 80.7 per cent of total net sales of the universe, 68.9 per cent of the operating profit, and 39.4 per cent of the net profit of the entire universe of 654 companies in 2014-15.
At the macro level, there has been a steady decline in companies' ability to service debt.
At this rate, many companies may be forced to default on their loans as profits from operations will be insufficient to cover the cost of debt servicing. The firms' interest cost on incremental debt is already trending higher than the underlying return on capital employed. In 2014-15, the cost of incremental debt shot up to 11.8 per cent, nearly 440 bps higher than the underlying return on capital employed.
At its peak during the financial year 2004-05, these companies reported a return on capital employed of 18.7 per cent more than twice their average interest cost of 6.9 per cent.
The last financial year was also the first instance in a decade when companies' interest expenses were higher than depreciation. The indebted companies of the sample spent Rs 2.03 lakh crore on interest payments in 2014-15, up from Rs 1.83 lakh crore a year ago. In comparison, their depreciation allowance rose marginally to Rs 2.02 lakh crore from Rs 1.9 lakh crore in 2013-14.
Thus, companies spent a greater part of their operating profits on debt servicing rather than capital expenditure and growth. In all, interest payments accounted for 34.2 per cent of the companies' operating profits in average last financial year, up from 16.7 per cent five years ago and 12 per cent a decade ago. This leaves little resources for growth capital.
Not surprisingly, analysts are worried about India Inc's growth prospects in the medium term. "If corporate earnings don't pick up quickly, I foresee more pain for banks, especially public sector banks. Ultimately, banks and their shareholders may have to take a haircut and write off large amounts of bad loans to kick-start capex and project lending," said Dhananjay Sinha, head of institutional equity at Emkay Global Financial Services.
Others see it as a purely cyclical issue, which will be resolved once growth resumes. "High corporate indebtedness is natural after a growth and capex boom. Once growth resumes and asset utilisation rates improve, the debt servicing burden will decline leading to improvement in banks' NPA levels," said Madan Sabnavis, chief economist, CARE Ratings.