Ratings show signs of peaking credit quality

India Inc faces the prospect of some pressure towards retaining its current credit ratings, says the rating agency Crisil. This is despite reducing the quantum of debt, raising fresh equity and generally managing to keep a lid on interest costs till now.

The agency attributes this principally to rising interest costs which are beginning to pinch Indian companies.

Crisil uses a simple measure called the modified credit ratio (MCR) to track India Inc's health on its debt servicing ability. The MCR is a ratio of the number of companies whose credit ratings were “upgraded” to those “downgraded”. This MCR was at a 10-year low in 2008-09, at 0.86, but has improved steadily to 1.1 in 2010-11.

Now, this is pretty close to the highest MCR recorded by India Inc way back in 2004-05, when it peaked at 1.16.

Difficult period

According to Crisil, the indicator is highly unlikely to reach its 2004-05 levels now for three reasons.

One, rising commodity prices may trim the profits of companies at the operating level. Two, rising interest rates, which are yet to fully impact companies, will hit overall profitability and three, growing competition will not allow companies to pass on these hikes to customers. Therefore, companies' ability to service interest costs and debt may come down. If a company is downgraded, that will further increase its borrowing costs.

Crisil flags that in the recent December 2010 quarter, the net profit margin of CNX 500 constituents (without banks and refineries) declined to 8.7 per cent from 11.3 per cent in September 2010 quarter. This, even as the quantum of rise in interest rates or raw material prices hadn't taken full effect in the December quarter. Therefore the best in terms of improving credit quality might be over.

Sector classification

The maximum upgrades were seen in the sectors of textiles, auto components, construction, steel, banks and industrial machinery. The upgrades in these sectors were predominantly due to equity infusion and new capacity additions improving the internal cash flows.

On the other hand, companies in steel, construction, textiles and industrial machinery have figured in the downgrades. Additionally, microfinance institutions, power and electrical components have also seen downgrades. The high degree of downgrades was due to increased levels of indebtedness, execution delays and rising raw material costs.

Crisil has also pointed out that cement, chemicals, construction, auto and textiles may be the most vulnerable to current raw material and interest costs, which may in turn affect the credit quality. Banks also have, over the years, reduced their exposure to these sectors.

Between February 2009 and February 2011, the share of credit to total industrial credit has fallen for sectors such as textiles (10 to 8.9 per cent), chemicals (6.8 to 5.8 per cent), all engineering (6.4 to 5.7 per cent), construction (3.7 to 3.1 per cent) and vehicle & vehicle parts (3.4 to 2.7 per cent).

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