Macro pressures ease, high leveraging & structural issues continue weigh : ICRA

A study of the rating actions for ICRA-rated issuers in terms of upgrades, downgrades and reaffirmations during the fiscal year 2014-15 reveals that both the number and severity of rating downgrades moderated during 2014-15, continuing with the trend that had started in 2013-14. Accordingly, the Credit Ratio for ICRA’s credit ratings improved to 1.9 times in 2014-15 from 0.9 times in 2013-14.   

Trend in Upgrades, Downgrades and Credit Ratio for ICRA Ratings

While company-specific factors drove a significant majority of the upgrades in 2014-15, the anticipated stability in the macro environment and an improved business outlook limited instances of downgrades. Also, the increase in the Credit Ratio in 2014-15 was influenced, to an extent, by the base effect, given that there were quite a few rating downgrades in the previous two years.

The key findings of the study are as follows:

• Of the total number of rating downgrades done by ICRA in 2014-15, around 83% pertain to issuers belonging to the non-investment grade.
• In 2014-15, sectors that showed a weaker Credit Ratio than the median—i.e. sectors that saw a greater proportion of downgrades than upgrades relative to the median—include Engineering, Sugar, Petroleum/Oil & Gas, Metals & Mining, Hotels and Real Estate & Construction.
• The primary factors behind the rating downgrades by ICRA in 2014-15 include stress on the issuer’s cash flows because of a weak demand environment and stretched working capital cycle, delays in project implementation (leading to cost overruns), and lack of financial discipline (resulting in delays in debt servicing).
• In 2014-15, sectors that showed superior Credit Ratio relative to the median include Financial Services, Auto Ancillaries and Pharmaceuticals.
• Of the total number of ratings upgraded by ICRA in 2014-15, around 39% relate to issuers in the investment grade. This proportion was higher than that observed in the previous two years as a relatively larger number of entities were able to appropriately adjust their business models and financing mix to the prevailing weakness in the economic environment.   

Outlook

The outlook for the performance of ICRA-rated entities hinges both on the macroeconomic environment and company-specific factors. Following change in the base year, improvement in methodology as well as enhanced coverage (for computation of GDP growth rate), India's economy is now estimated to have grown at a higher pace over the last few years (based on the new series). Moreover, the growth momentum has picked up further during the current fiscal (i.e. 7.4% in 9M, FY2015). Moderating inflationary pressures, initiation of rate cuts by the RBI and a comfortable current account deficit (CAD) are all positives for the corporate sector, going forward. The Union Government has also taken a series of incrementally positive steps to revive the investment cycle by committing higher allocations to infrastructure projects, besides addressing the need for introducing alternative funding sources. While all these steps are likely to improve the operating environment for the corporate sector, the continuing impact of structural issues on the execution of infrastructure projects, uncertainties related to the availability of key resources (coal, natural gas, iron ore, etc.) and the high indebtedness of certain corporate groups may thwart any sharp pickup in investment activity. More importantly, sectors like Metals, Capital Goods and Real Estate, which have been impacted the most by the economic slowdown, are yet to see any meaningful improvement in earnings. In addition, rural consumption demand could also be hit by factors like muted increase in the minimum support price and unseasonal rains. While foreign exchange volatility could create stress at the individual entity level, the impact of the same at the macroeconomic level appears manageable at this juncture, given the comfortable CAD position.

Overall, ICRA expects the trend of improving Credit Ratio (upgrades outnumbering downgrades) to continue in 2015-16 as well. Apart from cyclical recovery, companies are also expected to benefit from benign commodity prices, falling interest rates and an increase in Government’s plan expenditure. The fact that some of the highly leveraged entities are making efforts to monetise their assets and are now more cautious while bidding for new projects also marks a positive development from the credit perspective. While variables such as movement in interest rates and commodity prices will have a bearing on the credit profile of the corporate sector over the near term, any meaningful pickup in investment activity and industrial capital expenditure would begin to show up only over the medium term.