India Inc's financial health has worsened
With many economists for foreign brokerage firms arguing that the stock markets are factoring in a BJP-led coalition after the elections, and assuming that it will act in a decisive manner and introduce bold new reforms, it is worthwhile to temper this with hard reality. Apart from the obvious fact that opinion polls and poll results are very different, and we are around 6 months away from the polls, the pertinent question is about India Inc’s ability to respond positively to future reforms, no matter which party/coalition comes to power in 2014. A recent Credit Suisse equity research report, along with a presentation made by RBI Deputy Governor KC Chakrabarty offer interesting perspective.
There can be little doubt a decisive government will do wonders to corporate morale but, as the Credit Suisse report points out, India Inc’s financial health continues to deteriorate. In its sample universe of all listed companies (excluding financials and oil marketing firms) the interest cover—jargon for the ratio of ebit to interest payments—has fallen from 5 in Q2FY11 to a little over half that in Q2FY14. Worse, over a third of the debt in the Credit Suisse sample is held by firms that have an interest cover of under 1, as compared to around 25% in Q2FY12. In other words, were the de-choking of investment projects to take place as the Cabinet Committee on Investments (CCI) plans—presumably the next government, whichever party comes to power, will also have a CCI—it is very likely that a very large number of Indian promoters will not be in a position to either raise the equity or the debt for projects that suddenly get cleared. Of all the tables in the report, the one on individual company results is particularly evocative. In the case of Lanco Infra, while debt rose 134% between FY11 and FY13, this was accompanied by a 42% erosion in net worth. And there are many more like Lanco.
Chakrabarty’s analysis is even more interesting as it looks at the same picture, but from a banker’s perspective. At a macro level, it shows banks are simply not in a position to increase lending in a hurry since impaired loans have gone up from 6.8% in March, 2009 to 12.1% in March 2013 for PSU banks that account for the bulk of lending in the country. Why this is important, as Chakrabarty points out, is that were 30% of restructured loans to be written off, this would wipe out 18% of the capital of banks, thereby lowering their ability to lend. Given that as many as a fifth of cases before the Corporate Debt Restructuring (CDR) cell are likely to turn bad this year, up from 15% last year, banks could be looking at those levels of capital erosion.
More worrying, the dominant part of the banks impaired loans are in the infrastructure sector—there is, not surprisingly, a correlation between impaired assets of banks and the Credit Suisse list of firms with a low interest cover. There are 3 ways in which banks can clean their books—write off loans, upgrade the accounts to standard loans and increase recovery rates. The first two are not possible in large enough amounts unless the economy picks up significantly and the last can’t be speeded up due to structural problems in the manner in which debt tribunals work. In other words, both India’s corporate and its banks need some time to heal.