Concentration of high debt among some firms may pose risk to India: IMF.

New Delhi: High debt in some Indian companies may pose a risk to the country’s economic stability, the International Monetary Fund (IMF) said on Sunday.

A third of the corporate debt in India has a debt-to-equity ratio of more than three, the highest degree of leverage in the Asia-Pacific region, IMF said.

“In some countries, even though aggregate measures are not excessive, a large share of corporate debt is concentrated in only a few, highly leveraged firms. The distribution of leverage does matter and Asia clearly has ‘pockets’ of highly leveraged firms—including in China, Japan, India, and Korea—that may pose a risk to macroeconomic stability,” it said in its Asia Pacific Economic Outlook.

A high debt-to-equity ratio indicates that a company has been borrowing to fund expansion instead of raising money from the market. This can harm the health of a firm if interest rates rise and economic growth falters.

To be sure, an important mitigating factor is that debt owed by the highly leveraged firms in these countries is small relative to the overall size of the economies, IMF said.

As global liquidity recedes and interest rates rise, the cost of borrowing will go up, putting further strain on the corporate sector, the fund warned. More disaggregated data point to a considerably large share of debt being accounted for by weaker firms in countries including India, it said.

The weakest economic growth in a decade, high interest rates, slowing demand and delayed project approvals have hurt the ability of many corporate borrowers to repay debt. Growth slowed to 4.5% in the year ended 31 March 2013. IMF projected in its World Economic Outlook that growth in India will recover moderately to 5.4% in 2014-15 from an estimated 4.6% in 2013-14.

Of the $400 billion of debt held by 3,500-odd Indian companies, about 34% was with firms with low interest cover on 30 September, compared with 31% in the preceding quarter, according to a Credit Suisse report released on 19 November.

High corporate debt poses a systemic risk because it is widespread among sectors like infrastructure, power, road, textiles and gems and jewellery, according to Abizer Diwanji, partner and national leader of financial services at EY, a consultancy earlier known as Ernst and Young. “It could impact our exports as well as employment.”

In India and China, about half of the corporate debt is owed by firms with return on assets below 5%, and some of it is owed by firms that are posting losses, the fund said. Return on assets indicates the earnings generated by a company from its invested capital.

Similarly, a significant share of debt is linked to companies in countries such as India and Indonesia, where more than 20% of the debt is owed by firms with profit-to-interest expenses ratio of less than one. The lower the ratio, the more the company is burdened by debt. An interest coverage ratio of less than 1 indicates it is not generating sufficient revenue to repay interest on loans.

Only India and Indonesia among major Asian nations will face significant risks with the median interest coverage ratio for the entire corporate sector falling below 1, according to the 2014 Global Financial Stability Report stress tests.

When it comes to liquidity of companies, in the case of India and China, about half of corporate debt is owed by firms with current ratios below one, implying low ability to pay back short-term liabilities, IMF said. For Japan, Indonesia, Australia and Korea, this accounts for 30-40% of corporate debt.

Over-leveraged companies in India have put significant stress on banks. Reserve Bank of India (RBI)’s outgoing deputy governor K.C. Chakrabarty said in a recent interview that bad loans are an outcome of the non-performing administration. “If NPAs (non-performing assets) are high, everybody is responsible,” including central and state governments, policymakers and regulators, he said.

Gross bad debt of India’s 40 listed banks surged to Rs.2.43 trillion in December, a 36% jump from a year earlier, while restructured loans at the end of March rose to an estimated Rs.5-6 trillion.

Together, such loans make up about 12% of loans given by Indian banks.

“I think the concentration of debt due to the small base of large enterprises does pose its challenges and is a worrying phenomenon across emerging markets, including India. We could see a turnaround depending on post-election policy scenarios, but in the meanwhile, banks will have to deal with challenges of provisioning and allocating capital for risk,” said Shinjini Kumar, executive director at PricewaterhouseCoopers India, a consultancy. “The downside is that even if policy climate is set right, capital to fund growth will be scarce, slowing recovery.”

RBI governor Raghuram Rajan earlier this month warned bankers to avoid ducking a clean-up of their books by delaying the classification of assets that have turned sour as bad loans.

Speeding up loan recovery will help clean up their books faster, enabling them to finance more projects in the funds-starved infrastructure segment, Rajan said.

Doing so in times of stress will distinguish “the men from the boys”, he said, implying that only banks with strong risk management systems can effectively manage bad loans in the face of slower economic growth.

RBI rules require banks to set aside money to cover bad loans and restructured loans, hurting their profitability and resulting in the need for higher capital.

Banks need to set aside 5% of the total loan value for a newly restructured loan and anywhere between 10% and 100% of loan value if an asset turns bad.

To tackle the bad loan problem, RBI in January laid out a road map for early recognition of stressed assets in the banking system.

The framework outlined a corrective action plan that offered incentives for banks to identify stressed assets early and revamp accounts considered to be unviable. It imposed accelerated provisioning against sticky assets if banks and companies fail to adhere to the framework.

Source : livemint.com