Corporate debt. How serious is it?

In flagging the issue of corporate leverage, the latest Financial Stability Report of the Reserve Bank of India has underlined the gravity of the problem at a time when the country’s equity markets remain upbeat on hopes of a quick economic recovery and increased corporate profitability. The hard data does not support much of this optimism. There has been no turnaround in the financial performance of Indian companies. In the boom years of 2008 and 2010, Indian companies lined up aggressive expansion plans. But as the euphoria gave way to a prolonged slowdown, corporates with huge debts struggled to generate cash flows to meet interest payments. The debt-equity ratio for BSE 500 companies has gone up from 0.7 per cent in 2009-10 to 0.9 per cent in 2013-14, while their interest cover — a measure of a company’s ability to meet interest payments — halved to 3.6 times during this period. If this figure hasn’t sounded an alarm, it is only because some companies are cash rich. If one were to consider companies with a debt-equity ratio of more than 1, the interest cover would shrink to 1.8 times. Over the last six months, the debt servicing capacity of companies has only worsened, with interest cover slipping to 1.6 times; companies with a very high leverage, of more than 3, have an interest cover of less than 1, indicating that earnings are insufficient to meet interest payments.

The FSR report also flags the risk highlighted by the International Monetary Fund (IMF) in its report on Asian countries, including India. Apart from the increase in overall leverage, the report talks of the uneven and potentially problematic distribution of debt. A large share of corporate debt is concentrated in a few highly leveraged companies. About a third of total debt is owned by companies with a debt-equity of more than 3. These are also companies that are less solvent, which increases the risk of financial instability. About half the debt in India is owned by firms with return on assets that are below 5 per cent, and more than a fifth by companies which have interest cover of less than 1. Given the concentration of debt, the central bank, in the FSR report, has been right in pointing out the need to assess the risk associated with multi-layered structures — in the form of holding companies and special purpose vehicles.

Many companies are now deleveraging — paying off debt by selling off assets. JP Associates, for instance, has been selling its core cash-generating cement businesses to lighten its debt burden. But such deleveraging and cutting back on investments will only weigh on growth. The Centre should now focus on speedy clearance of stalled projects that will at least ensure that capital locked up in older projects start paying dividends. Only when this happens will companies look at fresh investments, which is imperative to revive the Indian economy. And this time, banks should ensure they have their risk assessment systems in place to address vulnerabilities that arise from high credit growth.

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