By Invitation. Signs of stability in corporate credit

Credit quality in the corporate sector went through a bumpy patch in 2012-13 and 2013-14, where there were sharp downgrades. Credit ratio — the ratio of upgrades to downgrades among new issuers — dipped to 0.3 and 0.9 times, respectively, in these years. In more recent years, the credit quality of the corporate sector has, however, been showing some signs of stability.

ICRA’s credit ratio stood at 1.8 times in the first half of 2015-16 This implies that a relatively larger number of issuers have continued to experience improvement in credit quality over the last 18 months than those that have seen deterioration. That said, the ratio is marginally lower than the 1.9 times in 2014-15.

Credit quality of a large number of issuers worsened in 2012-13 and 2013-14 because of slowing economic growth, liquidity concerns, currency volatility and elevated debt levels. Since then entities have benefited from improvement in the macro-economic environment, cyclical recovery in some consumption-oriented sectors and company-specific measures.

Also, a large number of upgrades have been driven by other firm-specific factors, including successful business diversification, efficient project execution and attainment of stronger competitive position.

That said, it must be highlighted that over the last three-and-a-half years, around 80 per cent of ICRA’s ratings have been reaffirmed at the same level, which indicates that for the bulk of the issuers, credit quality has not changed much. Also, the median credit rating of ICRA’s portfolio of rated issuers has remained in the [ICRA]B category over the last two years, compared with the median rating of [ICRA]BB in the preceding three years until March 31, 2013.

While an increasing trend in the credit ratio points to a likely improvement in the credit quality, the rating actions, when seen in conjunction with the volume of debt upgraded or downgraded, suggest that systemic credit quality is still under strain. This is also reflected in the large volume of debt restructured or refinanced and the still high leverage levels of a large number of corporates. Also, their profitability is moderate and working capital cycles are stretched. Improvement is yet to be seen in large sectors, such as metals, mining and infrastructure.

There are four key areas of concern from the credit perspective. One, high levels of debt of large groups; two, continuing stress in some highly capital-intensive sectors like power and steel; three, limited signs of revival in non-infrastructure capital expenditure against the backdrop of large overcapacity; and four, continuing sluggishness in the residential real estate sector and the resultant impact on construction.

While the prevailing weakness in commodity prices is likely to exert pressure on the credit profiles of producer entities, both food and non-food, this is a positive from the users’ perspective. The recent moderation in inflation and lower fuel prices has also supported urban consumption demand, reflected in healthy volume growth of items, such as scooters and passenger vehicles. Moreover, the recent upward revision in national daily minimum wage after a gap of two years is expected to support consumption demand.

Sector-wise, apart from the cyclical recovery in sectors such as medium and heavy commercial vehicles and auto components, good traction is also being seen in sectors like electricity transmission and distribution, renewable energy (both solar and wind) and urban infrastructure. However, overall demand revival may continue to be weighed down by factors including sluggishness in rural consumption owing to deficient rainfall and sluggish exports.

As for the asset quality of banks, ICRA expects non-performing assets (NPAs) to increase to 5.3-5.9 per cent by March 2016 from 4.7 per cent in June 2015 following withdrawal of regulatory forbearance. However, the volume of gross NPAs plus restructured advances could moderate from the levels of last fiscal as fresh NPA generation is expected to slow down.

The writer is Executive VP & Chief Rating Officer, ICRA

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