Not an A-lister? Credit just dried up for you

The rising risk aversion in the market indicates that sourcing credit for companies rated below the ‘A’ category is becoming increasingly difficult, said credit rating agency India Ratings (Ind-Ra). Consequently, ₹3-4-lakh crore of debt on the books of non-public sector entities rated ‘BBB’ and below could be impacted, it added.

The agency cited the adverse conditions in the interest rate market, increasing risk aversion by public sector banks (PSBs), a volatile external environment and limited access to alternative financing options as critical drivers for corporate credit quality in FY19, especially for weak entities (rated BBB+ and below). Collectively and concurrently, these could pose risks for the system’s financial stability.

Ind-Ra’s recent analysis of the top 500 corporate borrowers, who comprise about 78 per cent (₹43.6-lakh crore as of FY17) of the overall banking system’s corporate exposure, indicates that around ₹7.60-lakh crore debt is on the books of the non-public sector entities rated in ‘BBB’ category and below or have no rating outstanding.

Consequently, the agency estimates that in the absence of favourable liquidity/market conditions, refinance pressure (working capital renewals and replenishing run down of existing debt) could impact ₹3-4-lakh crore exposures (Vulnerable Set) of the sample set. These would remain reliant on banks for refinancing, given that in most of these cases, free cash flows would be inadequate for debt repayments.

As per the agency’s rating symbols, financial instruments with ‘A’ rating are considered to have adequate degree of safety with regard to timely servicing of financial obligations. Such instruments carry low credit risk. Financial instruments with ‘BBB’ rating are considered to have moderate degree of safety. Such instruments carry moderate credit risk.

PSBs’ limited lending

Ind-Ra expects the government’s infusion of ₹1.53-lakh crore (of which ₹88,000 crore was pumped in last fiscal) to be adequate to cover credit costs emanating from stressed assets.

“Barring 3-4 healthy PSBs, the FY20 CET1 (common equity tier-I capital) may be below the current regulatory requirements. This could increase banks’ risk aversion and could skew incremental lending towards better rated corporates, leaving lesser space for small and weaker credits,” the agency said.

NBFCs remain reliant on banks

Ind-Ra opined that in absence of PSBs, private sector banks and non-banking finance companies (NBFCs) could fill the gap with higher market penetration subject to their risk appetite.

“However, 50-60 per cent of ‘AA’ category NBFCs’ liabilities are sourced from banks, and this goes up for those rated in lower categories. Also, some banks could approach sectoral limits on exposure towards NBFCs. Consequently, NBFCs would capitalise on these opportunities and fill the credit gap to a moderate extent,” said the agency.

Ind-Ra believes the dependence on market-based financing is not free from headwinds, given the inadequate depth and skewed preference for investments. Also, given a sectoral cap for mutual fund investments, crowding out by large borrowers would reduce investor appetite for funding medium to small borrowers.

The agency felt that the domestic financing market could be impacted by rising externalities: i) elevated global yields and pressure on the Indian currency, ii) impact on input costs iii) abrupt outflow of funds from the country and iv) volatility in the currency markets.

While recapitalisation will partially restore PSBs’ ability in normal lending, frontloading and early infusion could address credit tightening to a certain extent.

Ind-Ra believes rising trade deficit, volatile capital flows and elevated cash in circulation necessitate an infusion of base money through open market operations. The requirement of base money creation is anything above Rs 2 lakh crore, given the expected nominal GDP growth of 10.9 per cent in FY19. This will also alleviate undue volatility in short-term money markets rates.

‘While the base money creation by the Reserve Bank of India could be done by back loading, a pre-emptive action will be judicious to reduce inter-temporal consequences. Thus, for the medium term, a well-capitalised banking system with efficient allocation of capital would be essential for sustainable economic growth,” it said.

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