Opinion

Credit rating and textile industries

Lionel Charles S. Srinath | Updated on November 14, 2017

The textile industry is capital-intensive and needs working capital to overcome price volatility.

The textile industry is plagued by volatile cotton yarn prices and inconsistent government policies.





The global financial fallout revealed the shortcomings of the credit rating agencies, and the failure of mechanism used to rate the securities. Though the sub-prime mortgage crisis is one of the largest scandals of our times, many of the credit rating agencies have managed to escape unscathed, unlike the investors and accounting firms involved in the Enron, Sathyam and Worldcom scandal.

In India, credit rating agencies have started playing a larger role, due to the Basel II norms, which require banks to provide capital on the credit exposure as per credit ratings assigned by an approved external credit rating agency. That many of the external credit rating agencies are still in their formative stage and don't have an understanding of the Indian business environment is revealed by the initial credit ratings being often challenged and corrected on strong protests by companies.

Usually, rating agencies, inter alia apply a range of qualitative and quantitative parameters like industry risk, operating environment corporate governance etc., besides earning measures, leverage measures, profitability measures, liquidity, capitalisation, etc., in evaluating the rating of a particular concern. However, we find that in the absence of thorough knowledge of various sectors of the industry, external credit agencies inadvertently apply rigid and uniform criteria for the rating process.

INDIAN TEXTILES

Since the market environment is very dynamic and constantly changing, many of the ratings assigned don't actually reflect facts on the ground, or the credit standing of the company. To our surprise, we find that even when SMEs apply for credit rating, credit rating agencies term the scale of operations as being ‘small', as a standard jargon. This raises a fundamental question on what rating agencies should follow in an emerging market like India, where several remedial measures are taken by the State on various sectors to keep the economy moving.

Let us have a look at the Indian Textile Industry. The industry accounts for 4 per cent of GDP, 14 per cent of industrial production, and 12 per cent of total exports. Acting on Government assistance to upgrade and modernise the industry under the Technology Upgradation Scheme which is ending on March 31, 2012, the industry had invested Rs 2 lakh crore, with the current outstanding debt remaining at Rs 1 lakh crore. Among the 226 listed companies, almost 83 per cent have shown poor results, and 127 companies reported net loss during the first quarter of 2011-2012.

The industry, which employs 35 million people, is working at 70 per cent capacity to retain workers and avoid social problems when the viable capacity utilisation level is pegged at 85 per cent. The current woes of the textile industry are compounded by volatile cotton yarn prices, inconsistent government policies of first restricting cotton and yarn exports, sudden glut in the domestic and international markets, resulting in accumulation of inventories, and closure of dyeing units in textile regions like Tirupur.

With plummeting exports to European markets, the levy of net excise duty of 5 per cent on branded garments in the 2011-12 Budget shook the industry like a cyclonic storm. Now, high inventory levels due to volatile prices and inconsistent government policies have left the industry with an estimated loss of Rs11,000 crore in working capital, and have eroded working capital limits.

CAPITAL-INTENSIVE

To avoid a large number of textile accounts becoming NPA or getting closed, the South India Mills Association has asked for rescheduling of loans on the earlier version during the 2008-09 crisis. As a matter of fact, the Finance Ministry is considering loan restructuring for textile units, after considering the industry's demand for resetting bank loans worth Rs 1 lakh crore.

According to Textile Secretary Rita Menon, the textile industry needs a 2-year moratorium on loans, so that working capital can be arranged for that time period. Hence, overall inventory levels, debtors, current ratio and gearings will be high for the industry. By nature, the textile industry is capital-intensive and it needs high working capital to overcome the volatility in raw material and finished good prices, compared to other industries.

If 80 per cent of textile units are reporting poor results, and the balance 20 per cent successful units apply for financial facility, a rigid application of uniform / standard parameters like inventory, debtors or current ratio would result in a low rating, while a successful industry in a cluster of major loss-making units would deserve a higher rating, for it has the ability and technical knowhow to surmount a volatile situation. However, the low rating provided by rating agencies on account of these industry-wide factors, results in an even lesser capital flow, and high interest cost for the textile industry, thereby exacerbating the situation and creating a graveyard spiral situation — an aviation term referring to a gradually tightening rapid spiral dive to the ground.

ECONOMIC RECOVERY

A sound economic recovery, or laying a solid foundation in a financial system, lies in enabling once successful ventures to recover and lift themselves up and make them join the mainstream of contributing effectively to India's growth, thereby rectifying economic imbalance. An impartial credit rating will remove all these uncertainties.

But for a few composite mills, the textile industry is served by small-scale fragmented units concentrating on various layers of the production process. This unique industry structure is primarily the legacy of the government policies that have promoted labour-intensive small-scale operations. This is a unique factor at Tirupur. The garment exporter coordinates the production process by outsourcing activities like knitting, dyeing, processing, printing, and so on, to units which specialise in such activities.

Such specialisation by small units helps the industry in many ways, like savings in large capital outlays for the exporting unit, providing flexibility in the production process in a fast-changing fashion-and-design realm by having a large variation of machines, achieving optimum capacity utilisation for the industry, and saving exporting units the trouble of having to manage a large workforce. Such being the case, credit rating agencies' terming SME's application for rating as “Scale of operation not large” in their rating, is like putting the cart before the horse.

It is important for credit rating agencies to understand special features affecting each Indian industry, and the policies of the government towards each such sector, and then apply the credit rating. It has a long way to go in this direction.

Here internal ratings, too, need a role. RBI, the Securities and Exchange Board of India, and some concerned ministries should also issue timely guidelines to lending institutions on matters relating to credit ratings, and close the gap between lending and allied groups like credit rating agencies, for better coordination in financial markets.

(The authors are with Verve Financial Services Private Ltd.)

Published on February 21, 2012

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