1 min read.Updated: 16 Sep 2016, 04:51 AM ISTLivemint
Indian companies are earning less on their invested capital than the cost of their debt
Chart 1, taken from a recent Morgan Stanley research report, shows debt as a percentage of gross domestic product (GDP) for the major Asia ex-Japan economies. Note India’s low leverage. Its increase in leverage between 2014 and the first half of 2016 has been a mere two percentage points, compared to 38 percentage points for China. Several Asian economies have high debt-to-GDP ratios, the saving grace being that most of the debt is domestic.
Chart 2 shows the excess return on assets over cost of debt for companies that are part of the MSCI index for the country, computed by Morgan Stanley. Excess return on assets is defined as return on assets minus cost of debt. Why are Indian companies shy of investing in fixed assets?
The chart tells you that’s because cost of debt is higher than return on assets by 0.7%. This means that Indian companies are earning less on their invested capital than the cost of their debt. Chinese companies are in an even worse position.
Says the report, “All things being equal, this means any further investments with debt would lead to a deterioration in EPS (earnings per share) and RoE (return on equity). In our view, the only way out of this problem is a major restructuring (cuts in excess capacity and occurrences of defaults), as growth has continued to disappoint, particularly in China."
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