Demand slowdown begins to pinch, India Inc's credit quality takes a hit

The demand slowdown, which has become a cause for concern for policymakers and corporate India, has begun to bite hard, if latest data is any indication. Analytics and ratings major CRISIL says as much as 86 percent of its total downgrades were the result of a slowdown in demand and stretch in liquidity caused by delays in receivables.

CRISIL’s credit ratio, the ratio of upgrades to downgrades, has come in at 0.87 times for the fiscal ended September 30, with 478 downgrades to 417 upgrades. The credit ratio has remained under 1 for the past two years. The ratings agency believes that the demand slowdown, coupled with high interest rates, will lead to mean credit quality remaining weak in the near term.

Bankers have also begun gearing up for the stress in corporate balance sheets. Some of the biggest bankers Firstpost spoke to say they are closely monitoring credit costs and keeping a close eye on the non-performing assets (NPAs). “The biggest task before us is to ensure that credit costs are in check and do not go up, given the turbulent environment,” the CEO of a leading private sector bank says.

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The asset quality of banks is bound to reflect the weakness in the external environment. Says Pawan Agrawal, Senior Director, CRISIL Ratings: “We expect the gross non-performing assets (NPAs) to increase sharply by 110 basis points to 4.4 percent of gross advances by the end of this fiscal, up sharply from 3.3 per cent last year. Furthermore, systemic weak assets are likely to rise by 140 basis points to 5.7 per cent of gross advances by the end of this fiscal, a significant increase over last year’s 4.3 per cent.”

Weak assets are gross non-performing assets (NPAs) plus 30 per cent of restructured standard assets (RSAs), excluding those of state power utilities. CRISIL says 30 per cent of RSAs have a high chance of slipping into NPAs over the next two years on account of the L-shaped economic growth trajectory expected.

Bankers feel given the environment, the retail side is more steady, and segments like home loans and vehicle loans are doing well. The small and medium enterprises (SME) side is stressed also because typically this segment has limited ability to withstand shocks. “On the corporate side, more than sectors, it’s the specific companies or groups we are keeping a close watch on for stress,” a banker said.

CRISIL’s analysis on 2,481 firms rated BBB- and above indicates that a fourth of these firms were highly vulnerable to demand slowdown and a sixth to liquidity constraints. “Working capital management emerged as a clear differentiator of credit quality. Firms with longer working capital cycles - or gross current assets (GCA) exceeding 240 days of sales - have witnessed twice the number of downgrades compared with upgrades,” Ramraj Pai, President of CRISIL, says. “On the other hand, firms with prudent working capital management, as indicated by low GCAs of less than 120 days of sales, witnessed more upgrades than downgrades,” he adds. Power, road transport and construction sectors had the highest downgrade rates, according to the ratings agency.

However, the fact that there are ratings upgrades shows there are companies with resilience. Pai says despite the tough economic environment, CRISIL continues to see rating upgrades. Almost 40 per cent of the upgrades were driven by firm-specific factors such as satisfactory track record of timely debt servicing by firms that were previously rated default grade, and an improvement in capital structure following higher-than-anticipated equity infusions or reduction in debt. “Another 25 per cent was due to better business conditions for firms that are not dependent on investment demand such as textiles, agricultural products and packaged foods sectors. These sectors witnessed the highest upgrade rates,” adds Pai.