Balance sheet turbulence

Balance sheet turbulence

Much of the attention has so far been focused on the macro consequences of the global credit crisis on the country’s economy, its balance of payments, its growth slowdown and so on.

Of course, the slowdown is expected to have an impact on companies, but most of the analysis has so far been confined to the deceleration in earnings growth or to job losses at companies. But the news that more firms are lining up to avail of the Corporate Debt Restructuring (CDR) mechanism with a view to rescheduling and restructuring their debt drives home the point that corporate defaults are likely to see a sharp increase.

To be sure, corporate balance sheets are less highly geared now than they were in the late 1990s. But this time, the stress in the system is likely to come from the overseas debt raised by companies. Not only is refinancing this debt difficult because of the seizing up of international credit markets, but the depreciation of the rupee also adds to the debt burden.

What’s more, many companies have issued foreign currency convertible bonds and most of these are unlikely to be converted into equity because stock prices are far below the conversion price. In the circumstances, the issuers have little option but to take them on to their books as debt. In some sectors, such as real estate, this balance sheet problem is going to get even worse as prices of inventories are marked down. The credit crunch in the local markets is also not going to help matters.

An analysis of the interest coverage ratio of companies shows that there has been rapid deterioration in the September quarter. Companies that are putting up projects are likely to be the worst affected. And while sales growth has so far been robust, falling demand is likely to change that very soon.

Simply put, we’re likely to see many more corporate defaults.

While the big companies can resort to the CDR mechanism, smaller companies may be driven to the wall. Under these circumstances, when banks are being forced to restructure their debts, does it make any sense for the government to ask the banks to lend more?

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