Deleveraging, domestic demand key trigger for rating upgrades of Indian firms

That India is somewhat of an oasis in a global picture of macro-economic concern has yet again been indicated by the country’s rating agencies. Global headwinds of economic sluggishness and dipping exports notwithstanding, Indian companies appear to be in the pink of the credit-health with credit rating going up depending on local consumption and averaging near decadal highs in certain industries such as cement, infrastructure, automobile riding momentum in cash flows, The Economic Times has reported. The situation points towards a revival in private-sector capital expenditure.

Most of the rating upgrades have taken place in the hospitality industry, auto parts, real estate, roads, power and financial service sectors.

One of the factors influencing the upgrades is the buoyant stock markets that paved the way for raising equity to get rid of expensive debt. Robust cash flows that mainly depended on the domestic consumption also helped the firms to go for conservative debt financing.

In recent months, there has been some stead improvement in capacity utilisation in capital-intensive sectors such as steel, cement and metals.

According to the report, the credit ratio assigned by rating agencies are the following – Crisil 1.91, ICRA 3.00, CareEdge 1.67 and India Ratings 2.65. Usually a ratio higher than 1 indicates more upgrades have taken place than downgrades.

Incidentally, credit rating agencies often use ratios such as debt/capital, debt/EBITDA, FFO (funds from operations)/debt to assess the credit rating of a firm.

“In relation to the global economic conditions, India is currently an island of relative calm. A strong upgrade momentum, and substantially fewer downgrades, including defaults, have supported the upward drift in the ratings. The reducing share of non-investment grade ratings has also contributed to this trend,” said K Ravichandran, chief rating officer at ICRA, the local associate of global major Moody’s.

“Infrastructure has benefited not only from high budgetary allocation, but also from better risk sharing among stakeholders and acceptance of investment vehicles such as infrastructure investment trusts,” said Gurpreet Chhatwal, managing director, Crisil Ratings, a unit of S&P.

Despite this upbeat feeling, stubbornly high sticky inflation beyond the comfort level of the Reserve Bank of India and higher borrowing costs always bear the risk of consumer demand shrinking in the domestic market.

Some sectors such as merchandise exporters (textiles, jewellery, specialty chemicals) are confronted with adverse trade headwinds in the global markets.

In the first half of the fiscal year, the biggest rating company in the country, Crisil, has carried out 443 upgrades, compared with 232 downgrades. ICRA did one downgrade for every two upgrades. The proportion of non-investment grade rating upgrades was 11% which was 200 basis points higher than the 10-year average. India Ratings upgraded 146 companies and downgraded 55 while CareEdge Ratings upgraded 217 companies and downgraded 130 companies in the April-September period.

As many as 20 sectors, such as automobiles, dairy consumer goods and renewable power could witness an increase of 10% in operating profits, said Crisil.

Another factor that supported the upgrades was the fact that for a few sectors consumers showed a distinct preference for premium products that led to higher margins.

“Supporting the rating upgrades were the mid-corporates, largely rated in the BBB and BB categories,” said Arvind Rao, head, credit policy, India Ratings. “They sustained their rating upgrades at more than 20% of the reviewed ratings,” Rao added.

For the moment, however, robust domestic demand continues to get the better of risks posed by a climb in interest rates over the past 18 months. But in sectors such as textiles, diamond, and specialty chemicals that carry considerable debt on their balance sheets can be vulnerable to financial stress due to high global interest rates and changing industry dynamics.

“The outlook on the cut and polished diamonds sector appears glum, with the sector expected to record a 22% decline in exports this fiscal, marred by weakness in consumption demand,” said ICRA “Substitution of part-consumption in favour of lab-grown diamonds, and the narrowing of the spread between polished diamond prices and rough diamond prices because of sanctions on Russia could adversely affect the industry,” said ICRA.