High corporate debt to wobbly revival: Why the current optimism about India's growth is misplaced

India Ratings' Deep Mukherjee has a warning for those who expect an economic revival only because there is a stable government at the Centre: your optimism borders on exuberance; it undermines some hidden risks.

In a recent interview to Firstbiz, the senior director - corporate ratings at the rating agency said that businesses are riding on hopes and there is no sign of consistent recovery in sight.

It is not clear whether the signals that we see now are really green shoots, he said.

"For instance, take the case of vehicle sales data. Passenger vehicles sales are better but the trend in commercial vehicles is not the same. It is the pick-up in commercial vehicle sales that would signal a recovery since that means transportation of industrial goods and mined commodities are happening," Mukherjee said.

According to data from the Society for Indian Automobile Manufacturers Association (SIAM), sales of passenger vehicles grew by 2.30 percent in April-October 2014 over the same period last year. Within the passenger vehicles segment, passenger cars and utility vehicles grew 3.03 percent and 7.02 percent, respectively. Sales of vans declined 15.62 percent.

Meanwhile, overall commercial vehicles sales fell 9.14 percent. Medium & heavy commercial vehicles (M&HCVs) witnessed a marginal 1.94 percent uptick, while light commercial vehicles fell a sharp 14.24 percent.

A bigger land mine is the high leverage levels of Indian corporates. He conceded that the leverage levels have not deteriorated from the levels seen in September 2013, but there has not been any significant recovery either. Due to the high debt, many companies will not be in a position to tap the opportunities that the economic growth will offer.

For instance, the infrastructure companies.

"You are putting the thrust on infrastructure for growth. But how many infrastructure companies are in a position to cash in on that? Most of them are debt ridden," he pointed out.

Some of India's most indebted companies are in the infrastructure sector. JP Associates has a debt of Rs 72,599 crore and its debt to equity ratio stands at 5.16. GMR Infra, meanwhile, has loans worth Rs 45,041 crore with a debt-to-equity ratio of 5.87. Gammon India and Hindustan Construction Company have higher ratios of 19.26 and 15.06, respectively.

However, the problem is not restricted to infrastructure companies.

"The solution to that would be equity infusion or asset sale. A lot of them (Indian companies, not only infra) have started on that path, particularly asset sales. But asset sales have a problem. If you sell more of your assets, your production capacity and your earnings will also suffer. So a heavy equity infusion is the need of the hour," he said.

And banks would not want to play a role as they are already straddled with a huge Rs 8.5 lakh crore stressed assets, which forms about 14 percent of their total loan book. In fact, India Ratings has estimated that in another five months the restructured assets of the banks will rise by another Rs 1 lakh crore.

For some of the weak corporates, an increase in global interest rates will only worsen the situation. This is because they have not hedged their forex exposure. Some of them argue that they have foreign currency earnings, but that, according to Mukherjee, is a baseless argument. Most foreign currency loans are linked to Libor.

If the interest rate increases and most of the foreign currency loans are linked to Libor, we would see a significant increase in the debt servicing outflow from India. If a currency depreciation happens simultaneously with a possible interest rate increase globally, then the weaker Indian corporates will be in quite a lot of trouble, he believes.

"When they had taken loans the forward premiums were much lower. Now the forward premium is between 7 and 8 percent. If you have a loan at Libor + 300 or 350 bps, you are looking at excess of 11.5-12% which is what you could have possibly got in India," he said.

In all likelihood, an interest rate increase in the US will result in a very high foreign currency outflow.

A currency depreciation, which is expected to happen once the US raises interest rates, will also be detrimental to the wobbly recovery. In an earlier report, India Ratings had said that 1 percent rupee depreciation will take away 1.2-2 percent of the operating profit of consumer durables companies. For oil and gas, the negative sensitivity is 1.5 percent and for others up to 2.15 percent.

"It (a rupee depreciation) will not only affect the sentiment, but it will also affect the balance sheet. We were any way expecting a protracted recovery. That would get further protracted. In extreme case, the recovery or the bottoming out may go into a tailspin. We do not know the extent of the outcome. Clearly we are very cautious," he said.

All in all, 8 percent growth is likely to be a tall call.

"We expect a marginally positive IIP in the next 12 months, the caveat being zero currency shock. As far as the global demand is concerned there could be issues in the exports sector. Capital goods IIP would always remain volatile. Given the high leverage the infra and construction companies have and the banks' exposure to the sector, the cap goods IIP would remain a spot of bother," he said.

Moreover, between 2004 and 2008 when Indian GDP was growing at a CAGR of around 9 percent, the global GDP was around 5 percent CAGR, Mukherjee points out.

"Those instances don't happen every decade. If the global GDP remains much lesser than those historical highs, it is difficult to predict to what extent India can grow consistently at 8 percent," he said.

With most experts predicting the global GDP growth at 3-3.5 percent, one should not expect India to grow 8 percent consistently for 3-4 years in the near future.

The Indian stock market has been on a dream run. Itis hitting record highs on a daily basis riding on global liquidity and on expectation of a quick turnaround. But the message is loud and clear. Is anybodylistening?

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Updated Date: Nov 11, 2014 13:47:20 IST