Mumbai: Corporate credit quality is showing early signs of recovery, according to credit rating agency Crisil Ltd.

The ratio of the number of rating upgrades to downgrades was at 1.64 times for the first half of 2014-15, the highest in three years, the agency said in a report released on Monday.

In the first half, there were 741 upgrades versus 451 downgrades, the report said, adding that companies with low debt saw positive trends in credit quality.

The improvement in credit quality will be gradual and any significant recovery will be contingent on a sustainable increase in investment demand, the rater said.

An improvement in business-related factors was the key driver for around 60% of the upgrades, Crisil said. “Credit quality buoyancy in the overall economy is still some time away; for that to happen, investment demand, which depends on the extent to which the central government pushes big-ticket policy reforms, needs to substantially increase," said Pawan Agrawal, senior director, Crisil Ratings.

However, the ratio of debt of the firms upgraded to that of those downgraded (excluding financial sector firms) remained weak at 0.59 times in the same period, reflecting continued pressure on systemic credit quality.

Export-linked sectors and non-discretionary consumer segments such as traders, packaged foods, pharmaceuticals, textiles and agricultural products saw the highest rate of upgrades. Companies in the construction, engineering and capital goods, and auto ancillary sectors had higher downgrade rates.

Indian companies have in the last one year tried to pare debt by selling assets. In the first four months of the current fiscal year, companies have put more than 17,000 crore worth of assets on the block, Mint reported on 2 August.

Meanwhile, the interest-paying ability of firms has also improved. The average interest coverage ratio of 389 companies on the BSE-500 index in the first quarter of 2014-15, excluding banks and financial companies, has improved to 5.1 times, from 3.99 times a year ago, the first year-on-year increase in four quarters, according to a Mint analysis.

The Crisil analysis also pointed out that weak liquidity and pressure on profitability were the major reasons for the downgrades. Firms with high debt levels, specifically with a debt-to-Ebitda ratio of more than four times, were subject to significant credit quality pressures, the report adds.

“Our analysis indicates that there is a sharp disparity in credit quality trends based on leverage, profitability and liquidity," said Ramraj Pai, president of Crisil Ratings.

The credit quality of export-linked sectors will improve, buoyed by the economic revival in US and the euro zone, according to Crisil. In the year to next March, the agency expects the Indian economy to record a growth of 5.5%, compared with 4.7% in the year-ago period.

Exports grew 11.5% in the first quarter of the current fiscal year, versus a decline of 2.8% in the corresponding quarter a year ago.

“With medium-term stability in currency, interest rates and oil prices, the revival of the manufacturing sector could ease pressures on the corporate credit quality," the report adds.

In the second half of 2014-15, the credit ratio of companies is likely to exceed 1, according to Crisil.

“As improvement in private consumption depends strongly on consumer and business confidence, the ability of the new central government to push reforms in the land acquisition Bill and labour laws will remain key monitorables in the second half of 2014-15," the report said.