Corporate credit profile posted its best performance in FY22, surprisingly, a year immediately after the unprecedented COVID-19 induced crisis.
India Ratings and Research’s (Ind-Ra) downgrade-to-upgrade (DU) ratio is at a ten-year low of 0.3 (FY21: 1.4). This marks a reversal of the trend of the past three years, where downgrades outpaced upgrades.
During the year, Ind-Ra raised the ratings of 276 issuers, representing 23% of the rated portfolio. Rating downgrades were significantly lower, seen in only 86 issuers.
Arvind Rao, Director of Ind-Ra, said: “For manufacturing and services companies, rating upgrades have been dominated by unprecedented deleveraging, strong revenue growth and margin expansion. These companies have been able to capture the surge in domestic and foreign demand and consolidate their market share. Companies have cautiously strengthened their balance sheets, using the resulting strong cash flows to reduce debt levels. To provide perspective on the magnitude of the improvement, for upgraded businesses, Ind-Ra expects median revenues to increase by 54% in FY22 compared to FY19, margin increased by 250 basis points and median net debt fell sharply to 1.7x from 2.5x. These businesses showed resilient performance in FY21, with most entities either maintaining their credit profile or being reclassified. That is, the upgrades are not a rollback of the previous year’s rating actions. Only 3% of issuers saw their FY21 downgrades reversed due to strong operational performance, underpinning Ind-Ra’s robust recovery framework put in place in April 2020, to assess ratings in a context of uncertainty.
Downgrades and defaults have been largely contained, thanks to the strong economic recovery and regulatory assistance in the form of liquidity support and ad hoc debt restructuring. This is reflected in the strong recovery in FY22 GDP, which is expected to come in at 8.8%, albeit from a lower base. Supportive monetary and fiscal measures such as the Reserve Bank of India’s Resolution 2.0 framework and the Emergency Credit Line Guarantee Scheme (ECLGS), which has been extended until March 2023, have also provided the liquidity needed by vulnerable sectors.
Key Industry Trends-FY22 | Ind-Ra
Suparna Banerji, Associate Director of Ind-Ra, said, “Positive rating actions were seen across almost all sectors in FY22, indicating a broader economic recovery. This contrasts with FY21 where upgrades were limited to a few sectors. A high number of upgrades have been observed in sectors such as chemicals due to the push for import substitution and increased export opportunities (China+1 strategy). The Pharmaceuticals business benefited from continued growth momentum, a good performance from the Indian business and cost optimization. The metals and mining sector was supported by strong performance and strong demand from end user sectors. (To compare FY22 performance, FY19 is used, as both FY20 and FY21 performance were affected by the pandemic.)
Rating downgrades were much lower in FY22 than last year. Among these issuers, more than half were already on a negative directional indicator. Liquidity pressure was the main downgrade factor in FY22. The stretching of the working capital cycle led to a deterioration of the net cash conversion cycle, which led to an increase in debt levels.
A few sectors, hard hit by the pandemic, continued to weaken. Sectors such as hospitality continued to be affected by operational restrictions related to COVID19. Capital equipment saw the most downgrades, constrained by working capital issues and reduced spending.
“A divergence in the recovery has emerged with the revival of medium-sized companies (under Rs 5 billion) lagging their larger peers. Large companies are considered to show a steady performance. says Rajan Chavan, Ind-Ra principal analyst. “This is evident from the fact that the DU ratio for medium-sized companies is more than 3x compared to large companies. One of the casualties of the slowing pace of recovery is reduced capital spending as mid-sized companies try to hold on to their balance sheets. Meanwhile, major corporations are continuing with their investment plans, supported by their stronger balance sheets.
Financial institution ratings remained broadly stable in FY22, supported by strong capitalization, ample liquidity and comfortable provisioning. Ind-Ra expects banking sector credit to grow 10% year-on-year for FY23, supported by a pick-up in economic activity, increased government spending on infrastructure, private investment and a resumption of the retail request. IndRa expects gross NPA to largely remain, although some stress will continue in the MSME and retail segments with a large restructured pool and ECLGS.
In a context of new capital raisings and improved profitability, banks should maintain healthy capitalization. Financial institutions are now better placed to meet the needs of Indian businesses over the medium term. Separately, structured finance transactions did not see much rating action in FY22, helped by improving market sentiment, leading to collection efficiencies reaching pre-COVID levels.
That said, while pandemic-related risks appear to be diminishing, geopolitical risks related to the Russian-Ukrainian war could dampen the pace of recovery. The immediate impact is felt through rising commodity prices, particularly soaring energy prices, the resulting rise in inflation, widening current account deficit and depreciation rupee.
IndRa’s initial assessment indicates that the impact would be largely limited to medium-sized entities and those at the bottom of the credit scale, as an increase in commodity prices could weaken their ability to service the debt.
Another emerging item to watch is the resurgence of COVID cases in China which are impacting global supply chains. The tightening of interest rates and the unwinding of various pandemic-related financing measures could create liquidity problems, especially for mid-sized companies. In addition, a likely slowdown in export demand and headwinds due to rising household debt and lower incomes will impact consumption.
Ind-Ra expects the pace of rating upgrades to moderate in FY23. Indian companies could see their margins shrink. As Russia’s invasion of Ukraine drags on, Ind-Ra has revised down its FY23 GDP growth forecast to 7.0%-7.2% from 7.6%. However, with Indian companies now in a better position to weather what looks like a tough year ahead, Ind-Ra has a stable outlook across all sectors.
(To receive our E-paper on WhatsApp daily, please click here. We allow the PDF of the paper to be shared on WhatsApp and other social media platforms.)
Posted: Friday April 01 2022, 11:23 AM IST