Has corporate India’s financial health improved?
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Economic growth in India has been hobbled by what has been termed the twin balance sheet problem—excessive corporate debt, mirrored in the mounting bad loans of banks. Companies are reluctant to take on more debt as a result, while banks are wary of lending. Do the corporate financial results for the March quarter show any improvement in corporate balance sheets, any signs of breaking away from this logjam?
One important yardstick to find out whether the corporate debt problem is getting better is to look at the interest cover. Interest cover measures the extent to which a firm’s earnings are sufficient to pay interest charges. It is the earnings before interest and tax divided by interest charges. The higher the cover, the more comfortably can the firm pay its interest expenses. The Centre for Monitoring Indian Economy (CMIE) database shows a distinct improvement in the interest cover of the manufacturing sector, excluding petroleum products. Interest cover moved up from 2.6 times for the December 2016 quarter to 3.2 for the March 2017 quarter. It’s easy to figure out why—banks lowered their interest rates substantially during the last quarter and this has been reflected in the financial results of BSE companies. One big reason for banks’ lowering interest rates, of course, is the huge influx of deposits as a result of demonetisation, which led them to lower deposit rates as well as loan rates.
In fact, the interest cover for manufacturing companies (excluding petroleum product companies) in the CMIE database for the March 2017 quarter was the highest in any quarter since September 2012. Lower interest rates have certainly helped companies in improving their ability to service interest on their borrowings.
Have all segments of the industry benefited? Some sectors have been badly affected by excessive borrowing and what matters is the improvement in these particular sectors. The CMIE database shows that the interest cover of companies in the construction and real estate sector has moved up to 1.6 times from 1.3 in the December quarter. That is an improvement, but the sector is still far from being out of the woods—interest cover for the sector was 1.6 in September 2016 as well. Indeed, interest cover for firms engaged in the construction of infrastructure deteriorated during the March 2017 quarter, falling to 0.4 from 0.6 in the preceding quarter. Any reading below 1 indicates the firm is not able to service its interest expenses.
Among other sectors severely affected by excess debt, the electricity generating sector saw an improvement in its interest cover, although it’s still below what it was in September 2016. The ferrous metals sector saw a sharp improvement in its interest coverage ratio, with an increase in the cover for steel, sponge iron, metal products and pig iron businesses. The textiles sector, however, showed only a marginal upgrade to 0.9 from 0.8 in the preceding quarter—it still means the sector as a whole is unable to pay its interest charges.
Several business segments saw deterioration in their interest cover from the December quarter. The most important of these sectors is telecom—its interest cover came down to a mere 0.3 times from 1.1 in the December quarter. Several telecom firms have been driven to the wall due to the intense competition in the segment as a result of Reliance Jio Infocomm Ltd’s strategies and banks will need to keep a wary eye out for bad loans in this segment, as Reliance Communications Ltd’s woes illustrate so well.
Apart from lower interest rates, the other way of being able to improve interest cover is by reducing borrowings, perhaps by selling off assets. The CMIE database shows that the total borrowings of the manufacturing sector, excluding petroleum products, fell by 0.6% from a year ago during the March 2017 quarter. The construction and real estate sector saw a small reduction in overall borrowings, with industrial construction and housing construction seeing the biggest drops. While some segments of the non-ferrous metals sector saw a decrease in borrowings, overall there was little change during the quarter. The electricity generation and distribution sectors continued to see higher borrowings. Once again, the red flag was raised by the telecom sector, which saw an increase in debt of 19.85% year-on-year in the March quarter.
But by far, the best way to pare down debt is to increase profits. Unfortunately, in the March quarter, operating profit, excluding one-offs and other income, of the manufacturing sector ex-petroleum products, went up by 15%, well below the 29% improvement in the December quarter, in terms of the CMIE database. The momentum in profit growth seems to be running out of steam. Growth in profits after tax excluding one-off items in the manufacturing sector ex-petroleum products too slowed in the December quarter. And in some of the sectors worst affected by excess debt, such as construction and real estate, metal products, electricity generation and distribution, there were overall net losses, after excluding one-off items.
In short, the March quarter financial results show that large parts of the corporate sector are still in frail health and there is a new debt problem looming in the telecom sector. The disruption as a result of the introduction of the goods and services tax could make things worse in the next couple of quarters. It’s no wonder there’s so much pressure on the Reserve Bank of India to lower its policy rate—the government feels this is essential to improve the health of the corporate sector, which is necessary if companies are to start investing again.
Manas Chakravarty looks at trends and issues in the financial markets. Respond to this column at email@example.com.