Singapore: While the Narendra Modi-led government in India has undertaken various reforms, the benefit of those steps is yet to be clearly visible in the operating performance of Indian firms, and this is partly on account of the subdued demand environment in the country as well as weak global trade affecting the export-oriented sectors, Standard and Poor’s (S&P’s) credit analyst Mehul Sukkawala said in an interview.
He also pointed out that asset-light sectors such as information technology and pharma have been generally doing fine despite subdued economic activity, and added these sectors were somewhat insulated from domestic pressures as they derive a significant portion of their cash flows from export markets, especially North America. Singapore-based Sukkawala also pointed out that the delay in clearance of the goods and services tax was a reflection on the political environment and added that it had implications for the operating environment in the country.
“Over the last 12 months, we have seen similar challenges for land reforms which was eventually shelved by the government, as well as absence of any significant labour reforms," he said. Edited excerpts:
What do you think are the long-term fallouts from the Fed rate hike?
S&P’s expects gradual increase by Fed over the next one year to about 1.25% or 1.5% by year-end 2016. We believe India is well-positioned to manage the Fed rate hike on account of our expectations of improving macroeconomic environment. At the same time, there is always a risk of volatility in the global financial market, especially if the market is surprised from any particular Fed action. In respect to Indian corporates, the Fed rate hike will potentially increase the cost of borrowings for Indian corporates borrowing abroad.
However, we believe the impact will be more than offset by the recent lowering of interest rates by Reserve Bank of India which will help Indian firms save on interest on domestic borrowings. Indian corporates with significant foreign currency borrowings also face a risk from any significant and sudden depreciation in the Indian rupee against the US dollar, especially if the company does not benefit from a natural hedge.
Sitting here in Singapore, how do you look at India—there is a lot that is happening and a lot that is not happening as well. One big talking point with regard to India—the Fed hike—is done with. So, what are the other key issues—is it the upcoming budget, or earnings, or rather lack of earnings recovery, that are the most important talking points for India?
The key focus continues to be on reforms and this need not be linked to the Union budget. Reforms related to fundamental aspects like tax, land and labour are important measures from a medium-to-long-term perspective for a country’s economic growth. The pace of reforms has been slower than what was expected by many market participants though they also recognize that it is not easy to implement fundamental reforms in the country. Investors are taking a more long-term view on the Indian economy rather than focusing on the next quarter’s earnings. They recognize the current weak financial health of the Indian corporate and banking sector.
So, their focus is on reforms as it will play an important role in the development of the corporate sector in the country over the medium to long term. Investors are also focusing on infrastructure spending. Everyone is aware of India’s infrastructure constraint and how the economy can benefit from the multiplier effect of infrastructure spending. So, the government’s push towards spending in sectors such as road and railways remains under focus. It is also important as the government is the only one right now who is in a position to spend and provide a push to the economy. This, in turn, could gradually change the operating performance and investment environment for the corporate sector as well.
It has been about two months since Amtek Auto’s $121 million debt default. Again, looking at this incident from Singapore, is this bond default a broader indication of how corporate India is suffering from a surfeit of debt?
Corporate India is facing a weak operating environment and the significant debt build-up over the last five years is not helping. This is especially true for the utilities, infrastructure, metals and mining and capital goods sector. The debt build-up was mainly towards new capacity addition in anticipation of increase in demand, whereas the reality is very different. The weak operating environment is resulting in significantly lower capacity utilization. Some corporates have also added leverage on account of rapid growth through acquisitions. All of these factors have adversely affected the debt servicing ability of many large and leveraged corporates and is also reflecting in the increasing trend in non-performing loans in the banking sector and defaults in the corporate sector.
What is your outlook for corporate India in 2016?
We believe the year 2016 would continue to be the year of consolidation for the corporate sector. Companies are focusing on improving their operating performance by completing ongoing projects, increasing capacity utilization and focusing on cost-cutting measures. They are also focusing on generating positive free operating cash flow. T
his is possible as companies are no longer launching new expansion projects. It has resulted in capital expenditure to continue its declining trend. The positive free operating cash flow is important as it allows companies to reduce debt on the balance sheet. In addition, some of the companies are also undertaking strategic deleveraging measures like selling non-core assets and raising equity though strategic partners. All of these should help companies improve their financial leverage.
Simultaneously, companies are also trying to refinance their existing debt to benefit from lower interest rates as well as longer maturities. It has been aided by schemes like 5/25. Such refinancing helps companies reduce pressure on their liquidity and match their debt maturities closer to the life of their asset.
It now looks like the GST won’t happen in this Parliament session. What will be its impact on 2016?
The potential postponement of the GST approval by Parliament to the budget session would make it impossible for the government to implement GST from April 2016. This is not desirable but it is important that it finally gets cleared even with a delay. It is an important reform for the indirect tax regime and is expected to provide a boost to the economy, sentiments and help improve operating efficiency for the corporate sector.
At the same time, the delay in GST clearance is more a reflection on the political environment and its implications for the operating environment in the country. It highlights the challenges faced by the government in implementing important reforms.
Over the last 12 months, we have seen similar challenges for land reforms which was eventually shelved by the government as well as absence of any significant labour reforms. Nevertheless, we have seen the government taking important measures to improve the operating environment in sectors like power, mining, especially coal and oil and gas. These measures do help support the profitability and leverage of many of the firms in these sectors. It is important because these sectors are capital-intensive and, therefore, generally carry high debt levels.
India has provided some details of its plan to phase out some tax exemptions for firms—what is your take on this? Is the road map clear? Does the government have to provide more clarity?
Simplification of direct taxes is a good step to bring in more efficiency into tax administration. It will also help reduce disputes between corporates and the tax department which in the past has resulted in fear and concern about India’s tax laws, especially among foreign investors. We believe more clarity will emerge as the government makes progress on its plans to lower the tax rates.
What are the key issues that you would like to see addressed in the coming Union budget?
Our focus is more on overall reforms which will help improve the operating and investment environment. These need not be tied to the Union budget.
Has the Modi-led government’s reforms so far been enough to unlock corporate growth?
The government has undertaken various reforms, though the benefit of the same is yet to be clearly visible in the operating performance of Indian companies. This is also partly on account of the subdued demand environment in the country as well as weak global trade affecting export oriented sectors. Nevertheless, we expect some improvement in consumption next year and also benefit from higher government spending on the infrastructure sector. This will possibly help companies improve their utilization levels. However, companies are still 9-12 months away from thinking about fresh investments.
Indian infra companies continue to be debt-laden—how do you see this being addressed?
Repairing the debt-laden balance sheet of Indian infrastructure companies is going to be a slow process. Like all other sectors, infrastructure sector is also adversely affected by the subdued economic environment. It has affected the cash flows of infrastructure companies. However, companies along with help from the government are focusing on completing the projects, including the ones that were stalled, and commissioning them. They are also focusing on issues that will help improve cash flows from their projects. This will allow firms to better manage debt servicing. In addition, it also allows these companies to look at the option of selling their operational projects at reasonable valuations or bring in a strategic partner to reduce debt levels. Some companies are also raising equity.
In addition, companies are also avoiding taking on new projects that will add to their current debt levels. Instead, they are focusing on more EPC (engineering, procurement and construction)-oriented contracts where they can leverage their project execution skills without material capital requirement.
You have shared a lot of views on the asset-heavy sectors. How about asset-light sectors like IT and pharma?
We all generally tend to focus on asset-heavy and, therefore, debt-laden sectors. These are in focus because of their importance to the economy as well as the stress that they are causing for the banking sector.
Asset-light sectors like IT and pharma have been generally doing fine despite subdued economic activity. These derive significant portion of their cash flows from export markets, especially North America, and this somewhat insulates them from domestic pressures.
Indian IT continues to register moderate growth, though faster than industry as a whole, and improve its market position in the global IT sector.
At the same time, the Indian pharma sector which was registering good growth till about a year ago has been facing some challenges. The key challenge faced by the sector is on the regulatory front.
They have been receiving many adverse comments from the US regulator (FDA) which adversely impacts their ability to supply to and grow the US market. In addition, the pace of growth has also been hit by slower approval from FDA for their new launches.
Nevertheless, we expect the large companies in both these sectors to manage their challenges and continue to improve their competitive position over the medium term.