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Can India Inc Raise Rs 7 Lakh Cr To Save Itself?
Over 260 of the country’s 500 largest corporate borrowers need a massive round of equity infusion to deleverage. But with fresh funding hard to come by, it will be a long winding road to recovery

At a time when the global economy is iffy and the market precarious enough to make debt, restructuring, interest rates and rate cuts a part of popular lexicon, stressed assets account for the biggest damage to the Indian banking system; currently, they comprise close to 10% of total lending.

Stressed assets refer to loans that have already been tagged as non-performing-assets (NPAs) or have been restructured by banks. With the Reserve Bank of India (RBI)’s push for greater transparency and early identification of such problem loans, the amount of loans that may be formally tagged as stressed could increase by a couple of percentage points in the near future. Of course, certain banks fare far worse than others, given that stressed assets as a percentage of their total lending book have already reached mid-teen levels. Such double-digit stressed asset rates were last seen in the 1990s; for the most part, between 2000 and 2010, the systemic NPA rate remained well below 2%. While the economy has been performing well during the past decade, banks have also earned appreciation for improving their credit underwriting standards and risk-management practises. In fact, there was a prevalent belief that double-digit systemic stress rates were a thing of the previous century. However, those expectations went down the drain when the economy tanked. Given that the true test of a risk-management system is how well it manages a downturn, the current systemic NPA raises some ugly questions about the same.

As we stand today, corporate leverage in India is at a decade high. Banks, which are already reeling under credit pressure, may not be willing to provide additional debt to companies that make up the core economy sectors, thereby hindering the revival of the overall economy. For any broad-based revival of the economy, it is critical that major corporates in sectors such as infrastructure, construction, metals and mining have sufficient balance sheet strength to fund the next round of growth (see: In dire straits).

Unfortunately, most corporates in these sectors do not have the strength required to tap growth opportunities; an immediate solution would then be to reduce, at least moderately, the leverage levels of these companies.

As per a recent India Ratings & Research study, 262 of the country’s 500 largest corporate borrowers would require an equity infusion of a whopping Rs 7 lakh crore ($114 billion) for this purpose. One could always wait for the economy to turn around and the operating performance of these corporates to improve, but according to the study, it would take five to six years for leverage to lessen through such an organic route. If there are any domestic or external shocks during this timeframe, these corporates could then slip into the stressed category; in addition, these corporates would then have limited access to debt funding during this period and would likely exhibit below-par growth. So, how did this issue careen to such monstrous proportions and what is the way out for both corporates and banks?

Road To Perdition

Credit problems of this stature do not occur overnight. A significant number of players in this credit bust ascribe reasons such as policy paralysis for their problems. While policy paralysis and global uncertainty may have had definite roles to play in this mess, fixing the entire blame only on these factors externalises the problem. The implication of these excuses is that the entire credit infrastructure — an all-encompassing term used to describe borrowers, lenders, independent third parties as well as the legal and regulatory framework — had no significant shortcomings. However, as RBI governor Raghuram Rajan has himself taken great pains to point out in the past, more than one constituent of the domestic credit infrastructure requires rethinking. It may be argued that the seeds of the current credit bust were sown in FY10-FY11, when, ironically, Indian growth was recovering post the global financial crisis. But before one gets there, it may be worthwhile to study corporate growth and debt growth dynamics for the past decade.

Seeds of the credit bust were sown in FY10-FY11 when growth was recovering
During the 2004-2008 period, leading up to September 2008, the infamous Lehman moment, debt on the balance sheets of the 500 largest corporate borrowers grew in tandem with their Ebitda growth, while the median leverage remained within a healthy range of 2.3 to 2.5. [Here, leverage is measured as net debt of the corporate, divided by the Ebitda.] The systemic NPA rates at this time were at historic lows of around 1%. However, even during this boom phase, the cracks in risk management of both Indian banks as well as corporates were amply visible to all — some Indian corporates had paid heavily for their ill-considered dalliances with foreign currency derivatives, while other prominent names in the Indian corporate fraternity were close to defaulting or had already defaulted.

In addition, the real estate market had already been tagged off as overheated, with a flurry of defaults by well-established companies. During each of these domestic mini-crises, corporates and their lenders pinned the blame on each other, though the jury is still out on who was the culprit.

From September 2008 to the climax of the sub-prime crisis in October 2009, banks severely curtailed credit availability. Thus, balance sheet debt of corporates, which was then growing at 25% to 40% on a year-on-year basis, met a roadblock. Given the uncertain environment back then, Ebitda growth nosedived to around 10% from the 25-40% growth seen in the previous four years.

There was a flurry of defaults, mostly from corporates with huge unhedged foreign currency exposure or those whose businesses were linked to global trade channels. Though corporate leverage continued to deteriorate, the situation was still not as worrisome. To the credit of the government and RBI governor back then, significant steps were taken to shield the Indian economy, with the former cutting loose fiscal strings to push up the GDP component of community, social and personal services (CSPS). This component shot up by 36% (y-o-y, current prices) for Q3FY09. In the following four out of five quarters, this component grew at 20%+ rates.

The equity required by distressed corporates is five times their market cap
But FY10 and FY11 were the real inflection points in the economy in more ways than one. India returned to an 8%+ GDP growth trajectory, with a minor hiccup in FY08. Market observers and laymen all focused on these two years to draw the grand conclusion that India was a purely domestic growth story far removed from what happened in the rest of the world. Few, if any, focused on the fact that the FY04-FY08 period was unique in the global economic scenario. As such, global GDP growth of close to 4% for four to five years in a row — as in the case between 2004 and 2007 — empirically occurs only once every two decades; the last such high-plateau global GDP growth rate occurred between 1984 and 1989. What was unique about the 2004-07 global growth was that apart from the US and the BRIC nations, over 40 countries had exhibited peak growth rates during this period. However, this correlation of Indian growth with the global scenario was generally overlooked by a significant number of financial decision-makers.

The surge in corporate profitability between FY10 and FY11 was largely attributed to the leadership brilliance of India Inc. While this may be true, limited references were made to the Kalecki Profit Equation, as per which the drivers of an economy-wide increase in corporate profitability are creations of investment assets in the economy, dis-saving by households and incremental fiscal deficits by the government. Given that the government had to tackle a surging fiscal deficit since FY10, putting a stop to its spending, households also stopped splurging and corporate profitability started to nosedive post FY11.

Nonetheless, bolstered by the self-belief that the banking system’s credit started flowing back from November 2009, corporate Ebitda growth rate did crawl back to above 20% in FY10 and FY11 from the lows of FY09, while leverage remained at elevated levels of 3 and above. With the benefit of hindsight, one may say that the misconceptions and excesses during this period were among the possible contributors to the current credit bust. By March 2012, however, the intensity of negative news flows and on-ground developments had vitiated the business environment. Scams, policy logjams and rupee depreciation followed Murphy’s Law with precision, the cumulative outcome being that the median leverage levels of top Indian borrowers have touched 5. Currently, nearly one in three corporates barely earn enough to service even their interest obligations (see: From boom to bust).

Achche Din Ahead?

The positive developments of the last six months, then, have brought about a revival of hope, the key driver of which is a majority government at the Centre, led by an eloquent leader who has a track record of successful governance in his previous roles. While the central government can provide a stable business environment and policy framework, at the end of the day, corporates are required to conduct the actual on-ground activities, and these activities require funding; that’s precisely the biggest challenge for reviving growth in India. A lot of currently overleveraged corporates have banked on debt for growth.

This had been relatively easy back in FY10-FY11, with bankers buying into the theory that Indian growth was decoupled from the rest of the world. However, they possibly forgot that economic downturns still exist and thus, ended up underwriting long-terms loans with an assumption of an 8% year-on-year GDP growth rate till judgement day. Consequently, then, bankers’ appetite for fresh loans to overleveraged corporates is currently low (see: Playing it safe). This is classic pro-cyclical behaviour by the banking system, where excess credit deployment in boom time is followed by excessive risk-aversion accompanied by loan sanctions during downturns. Thus, what corporates truly need today is to bolster their balance sheets by infusing good old-fashioned common equity.

About Time Now

The urgency of equity capital requirement is the highest for 63 corporates that have either been tagged as NPAs or are undergoing distressed debt restructuring processes (see: The downtrodden). These corporates require Rs 2.4 trillion as equity over the next six to 12 months so that they can remain actively functional as corporates. However, the equity required by most of these corporates is on an average five times their market capitalisation. To raise even a portion of this required equity, the current promoters would, in all likelihood, have to cede control of the company or sell it off altogether. There is a high likelihood that many of these corporates will not be able to raise the required amount of equity, continuing to languish on the balance sheets of the Indian financial system for five to 10 years before being finally liquidated.

Among the 262 corporates on the waiting list for an equity infusion, 128 boast of leverage higher than their historical average, but with their business profile and reputation intact. These corporates need equity capital to fund their next round of growth, but, not surprisingly, the equity required to be raised is well below a lot of their market capitalisations. Of course, in at least some of these cases, the promoter holding post issuance of equity may fall below 26%. In these cases, more than anything else, the reluctance of some of the promoters to cede control may be the biggest roadblock in raising equity. The next round of the investment-asset creation cycle, which is widely expected to bring the economy back on track, is clearly contingent on these 262 behemoths of corporate India being able to infuse equity into their balance sheets. Any reduction in the interest rate will give some breathing space to these overleveraged corporates; however, in the absence of significant equity infusion, a revival of future investment cycle is somewhat overoptimistic.

However, all is not lost. During the period of credit excess, close to 180 large corporates zealously guarded their balance sheets against debt excesses and currently do not have any urgent need of equity capital; their leverage continues to remain healthy. These corporates should be able to access the capital of their choice without too many constraints. In fact, the financial flexibility that they enjoy gives them a competitive advantage over their highly leveraged industry peers. It is some of these companies, then, who will be the flagbearers of the next round of growth.

The author is senior director, India Ratings & Research (Fitch Group)

Views expressed by him are personal

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