Indian corporates under debt stress, says McKinsey study

Vivek Ananth | Updated on August 27, 2019

BL Research Bureau

Indian companies are under severe stress to service their debt obligations, according to a study by McKinsey & Company on the indebtedness of Asian corporates.

The share of their long-term debt having an interest coverage ratio of less than 1.5 times of operating profits rose significantly over the past decade.

The low interest coverage ratio shows that a large part of the earnings is going to service debt and any spike in interest rates could trigger a debt crisis in Asia. Most of the concentration of stressed debt in India is among industrial, energy and utilities sectors.

This puts in context Reserve Bank of India’s rate cutting spree over the past few monetary policy committee meetings since the new governor took over in late 2018. The frequent rate cuts have cushioned some of the blow of high indebtedness among Indian corporates.

At the end of 2017, the share of long-term debt with an interest coverage ratio of less than 1.5 times the operating profit, accounted for 43 per cent of overall debt.

Nearly two-thirds of the stressed debt is concentrated among companies that operate in energy, industrial and the utilities sectors.

The industrial sector, which is made up of capital goods manufacturers, warehousing and storage service providers among others, made up nearly one-third of the total stressed debt in India in 2017, the study says.

Crisis averted?

The change in stance of the Reserve Bank of India which has cut the repo rate by 110 bps since February 2019 has probably helped Indian corporates avoid a serious debt scare. A high interest rate scenario might have seen Indian corporates struggle to repay their outstanding debt.

Just to illustrate, a 2018 study by McKinsey estimated that a 200-bps increase in interest rates would increase the value of distressed bonds issued by non-financial Indian corporates by 50% to $27 billion.

The RBI’s four continuous rate cuts in 2019, and a low interest rate scenario in India has lowered the likelihood of a debt crisis in India. Transmission of these rate cuts remains the key now.

However, if the trade war between the USA and China continues and as a result foreign capital flows evaporate, there could be an increase in debt stress in Asia, which could impact India as well, the McKinsey study says.

Published on August 27, 2019

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