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Problems faced by Indian companies and banks

, October 7, 2013, 0 Comments

Problems faced Indian companies and banks

Problems faced by Indian companies and banks are as acute as India’s inability to bolster its free-falling currency or mending its worsening economy

Debt-ridden corporate sector
The banking sector has witnessed strong loan growth in recent years, mainly driven by few large companies. According to a Credit Suisse report, the gross debt of 10 large Indian conglomerates (which account for 13 per cent of bank loans and 98 per cent of banking system’s net worth) was over $100bn over the last financial year, indicating a rise by 15 per cent in last one year.

However, with rising debt levels, interest cover for most of the companies has declined further. The interest coverage ratio[1] of these 10 large corporate groups has dropped from 1.6  in FY 12, to 1.4 in FY13. This means that these conglomerates would have to pay 71 per cent of their operating profits to pay interests on their outstanding debt, a significant rise from 62 per cent last year.

Given the high leverage levels, poor profitability and pressure from lenders, virtually all of the ten debt-heavy groups have initiated to divest part of their assets (cement plants/power/road projects). However, given that most of the domestic infrastructure developers are already over-geared, demand for these assets may be limited.

The reason for the high debt burden of Indian companies can be traced back to borrowing trend in the past. Between 2002-03 and 2007-08, private corporate investment as a percentage of India’s GDP rose from 5.7 to 17.3. Subsequently, it fell to 13.4 in 2010-11, but was still higher than the single-digit levels of early 2000s.

The spurt in investments was largely financed through large-scale borrowings, combined with the confidence that the projects executed would generate sufficient returns to service the debts. Moreover, the large differential between domestic and overseas interest rates, combined with the belief in a perennially strong rupee, emboldened corporates to increasingly resort to ECBs (external commercial borrowings).Currently, the non-government foreign debt is approximately 16 per cent of the GDP.

A weakening rupee has only added to the corporate sector’s woes
Many corporates’ loans are 40-70% foreign currency denominated; therefore, the sharp depreciation in the rupee is adding to their debt burden. In FY13, with only a 6.7 per cent depreciation, corporate groups such as Reliance, Adani and JP saw a foreign exchange hit equivalent to their profit-after-tax. With Rupee down by over 20 per cent since April, this stress will only be exacerbated for these corporates.

Limited hedging practices of companies
A study by Fitch of 290 investment grade corporates has shown that only 42 per cent corporates with foreign exchange exposure followed hedging practices. However, a benefit of natural hedge is available to net importers selling at import parity prices. Among the 290 corporates, 82 per cent of foreign exchange debt was held by net importers.  The report further indicates that majority of foreign exchange debt was in Oil and Gas sector (68 per cent) , followed by Metals and Mining (12 per cent).

Deteriorating asset quality remains a primary concern
The gross non-performing assets recorded an average growth of 24.7 per cent in last six years to reach $ 30 billion in March 2013. The loss to banks due to Non-Performing Assets(NPAs) has been more than 60 per cent of their net profit since 2010. In addition, banks have to spend about 18 per cent of their net interest income for making risk provisions and write-offs of NPAs. RBI estimates suggest that had the NPAs not been there, the banks would have improved their yield on advances, by 124 basis points.

Public sector banks (which account for almost 70 per cent of banking assets) share a disproportionate burden of this increase. While gross NPAs and restructured advances for banking sector as a whole increased to 9.3 per cent from 7.5 per cent last year, the increase was from 9 per cent to almost 12 per cent for nationalized banks.

In such a situation, banks are likely to face a capital shortfall, even as economic growth and consumer spending has slowed down and borrowing costs continues to rise with tightening liquidity. The obvious impact on the corporate sector would be further squeezing of credit, hindering their investment plans.

[1] Interest cover ratio is calculated by dividing a company’s earnings before interest and taxes (EBIT or operating profit) for a year by the interest to be paid on the outstanding debt, for the same year.

Photography by : Mahesh Puthran