Third quarter corporate earnings have been terrible, but the credit crunch has now shifted attention to balance sheet risks. The International Monetary Fund’s (IMF) update of its Global Financial Stability Report warns about balance sheet risks in emerging market firms. Here’s the relevant extract: “Looking forward, emerging market countries, particularly corporate borrowers, remain vulnerable to continued deleveraging and credit retrenchment.”
The Reserve Bank of India’s report on Macroeconomic and Monetary Developments says that the flow of resources to the commercial sector so far this fiscal year, at Rs4,84,713 crore, is not very much lower than the Rs4,99,484 crore made available over the same period of FY08. But the situation has worsened considerably over the last couple of quarters.
For instance, out of the amounts mentioned, most of the external commercial borrowings happened during the first quarter, as did the ADR/GDR (American/global depository receipts) issues.
A higher level of foreign direct investment, or FDI (Rs53,595 crore against Rs19,125 crore in the same period of FY08), is to a large extent responsible for showing a high resource flow to the corporate sector this year. But this FDI goes only to very few firms and the International Institute of Finance has warned that FDI levels are likely to drop sharply this year. In short, as IMF says, corporate balance sheets will be affected by credit retrenchment.
Daniel McCormack, equity strategist at Macquarie Securities, points out several sources of insolvency risk. These include: earnings deterioration, customer defaults and higher account receivables, supplier financing problems, refinancing risk and currency mismanagement. He says account receivables rose by 5% of sales in the Asian crisis.
And then there’s the risk that crisis-hit banks in the G-3 countries will call in loans made to Asian companies. Claims of G-3 banks from India amount to $188 billion (about Rs9.2 trillion today), says Macquarie Securities, although it anticipates no problems for India as a whole. The countries most at risk from refinancing issues in Asia are Korea, Thailand, Singapore and Taiwan.
As a note on equity strategy from Ambit Capital Pvt. Ltd puts it, “Sectors that are seriously impacted by leverage include commodities, real estate/construction, banks and industrial sectors. Over the past few years, operating and financial leverage supported the growth in earnings. In the current downcycle and a deflationary environment, we expect the advantage of leverage to reverse.” Ambit predicts Sensex earnings to be Rs800 in FY09 and Rs750 for FY10, much lower than Bloomberg mean estimates.
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