The credit quality of India Inc and that anti-fragile vibe
PremiumIndia Inc has weathered the pandemic well but the ongoing war in Europe could cause some blips
Policymakers and India Inc responded with restraint to the emergence of a third wave of covid infections fuelled by the virus’s Omicron variant. The steep learning curve afforded by the two-year pandemic has seen us move from the ‘world’s most stringent’ restrictions to a more pragmatic ‘living with the virus’ approach. Hard curbs seem passé, in large part due to the ring-fencing provided by that staggering government achievement on vaccination: over 1.8 billion jabs in over a year.
However, Russia’s invasion of Ukraine and the punitive sanctions imposed on the former by the US and European nations has the potential to impact India Inc in two ways. One, higher commodity prices can squeeze the margins of downstream sectors, in case they cannot pass on input costs. And two, its impact on trade activity in that region could affect growth for sectors dependent on those markets. Still, a broad-based improvement in credit quality has been observed despite the intensity of covid’s second wave.
Crisil Ratings’ credit ratio (upgrades versus downgrades) rose to 2.96 times in the first half of 2021-22 from 1.33 times in the preceding half. This trend accelerated in the second half of the current fiscal year.
There have been three drivers of this: first, a demand recovery; second, strengthening of India Inc’s balance sheets and the optimization of its cost structures; and third, accommodative policies and support from the government and regulators.
The demand recovery seen in recent quarters was spurred by public spending on infrastructure projects, surging exports and domestic consumption. These spurs should sustain over the medium term, given the recent budget’s announcements—total capital expenditure facilitated by the Centre is budgeted to rise 14.5% in 2022-23. This, and the long-term financial assistance to states for capex, should spur medium-term demand in infrastructure-linked sectors.
A recent Crisil Ratings study of 43 sectors (accounting for over 75% of the ₹37 trillion rated debt, excluding the financial sector) shows that revenue for 37 (more than 90% of the debt under study) has fully or largely recovered to pre-pandemic levels. Only six have some way to go before full recovery. Companies have withstood two big waves of the pandemic by reorienting their business models, improving supply-chain and inventory management, pruning costs, and also bolstering liquidity. Besides, a secular deleveraging trend, evident across sectors, has continued through the pandemic. This was helped by plans for lower capex by firms.
An analysis of about 4,200 of them (excluding those in the financial sector) rated by Crisil shows a decline in gearing to about 0.7 times, as of 31 March 2021, from over one time as of 31 March 2015.
Contact-intensive and mobility-linked sectors such as civil aviation, airport operations, education, hospitality, retail and two-wheelers—worst affected by earlier waves—remained vulnerable.
The war has sent crude oil prices soaring. This will squeeze profit margins in sectors such as oil marketing, chemicals and paints. A prolonged war could constrain supplies of natural gas, crude sunflower oil, rough diamonds and semiconductor chips. A clearer picture, including of the credit quality of affected companies, will emerge only once the geopolitical situation improves.
Broadly, higher inputs costs and limited space to pass them on would moderate India Inc’s profitability this fiscal on-year. The emergence of new variants and effects of the war remain key risks to our credit-quality outlook.
Then there is the question of size. While large corporates have fared better—supported by their strong balance sheets and access to funds—micro, small and medium enterprises (MSMEs) have borne the impact of the pandemic disproportionately. They are also vulnerable to the current geopolitical risks.
Financial-sector entities have a ‘stable’ credit quality outlook, and are expected to see higher growth this fiscal year and the next. Clearly, the banking sector will play a critical role in supporting the budgetary focus on capital expenditure, while the extension and enhancement of the Export Credit Line Guarantee Scheme is also credit-growth positive.
Overall asset quality is likely to improve on the back of a reduction in corporate non-performing assets (NPAs).
However, the performance of the MSME segment and restructured portfolio bears watching.
In the case of non-banks, reported gross NPAs should improve.
The recent deferral of the implementation of NPA upgradation norms provides a reasonable transition time for non-banks to recalibrate collection processes and educate borrowers on aligning themselves with the new dispensation. Coupled with an expected improvement in the economy, we expect gross NPAs for non-banks to reduce 150-200 basis points by 31 March 2022. That said, asset-quality metrics will likely remain sensitive to the performance of restructured portfolios.
However, most Crisil-rated non-banks have improved their balance-sheet resilience over the past three fiscal years, as reflected in the troika of improved capital, provisioning and liquidity buffers.
The structurally salutary part is that India Inc seems to have used the crises of the past two years to become more resilient.
New risks have emerged for sure, but there is that anti-fragile feel, too,
Gurpreet Chhatwal is the managing director of Crisil Ratings
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