Ever since the car started sputtering in September 2018 with the IL&FS episode, the journey has not been smooth. Every other day, a new pothole is discovered. Some credit rating downgrade, some default or delinquency, or other issues have been there in the grapevine. Losses have been suffered in investments in bonds, mutual funds and even provident funds. Though the credit environment looks depressing, things are not as bad as they seem. It is not yet time to withdraw your investments from fixed-income securities. Here’s a perspective on the negativity.
Firstly, the “contraction" of the economy. For the sake of clarity, for a country where GDP (gross domestic product) was growing at a rate of, say, 7%, if the rate of change shifts to, say, -7%, the economy is de-growing or contracting. However, if the rate of GDP change shifts from 7% to say 6%, the economy is not shrinking, but growing, though at a slightly slower pace. For a contracting economy, where corporates are de-growing, debt servicing becomes that much difficult. There are headwinds on growth rates in certain sectors, but as long as the growth rate is positive, which is the case, we need not be as negative on the outlook.
Secondly, on the credit environment, let’s take the action of credit rating agencies as a proxy. These agencies publish data on the number of upgrades and downgrades in the period under review, and that gives a perspective on the health of corporates.
To start with Crisil, there are two ratios; one is the upgrade-downgrade ratio which divides the number of upgrades in credit rating during the period by the number of downgrades. The other one is debt-weighted upgrade-downgrade ratio which takes the outstanding debt of the rated entities as the weight. A number more than one is positive as it signifies more upgrades than downgrades. In the second half of financial year 2018-19 (FY19), the credit ratio i.e. number of upgrades to downgrades was 1.81, better than 1.68 in the first half. There were 594 upgrades against 328 downgrades. The debt-weighted credit ratio was 0.89 in the second half, lower than 1 and lower than the first half of the year. However, this was primarily due to downgrade of two large telecom companies, which accounted for 56% of downgraded debt by value. Otherwise, the ratio was 2. Over FY2018-19, the credit ratio was 1.73 and debt-weighted credit ratio was 1.65, both comfortably positive.
ICRA calculates it as the average upgraded notches per rated entity, minus the average downgraded notches per rated entity. This was -12% in FY19, against -11% in FY18. On the value of debt, ICRA upgraded ₹3.6 trillion in FY19, significantly higher that the debt of ₹1.8 trillion upgraded in FY2018. The downgraded quantum was higher as well, ₹3.2 trillion against ₹2.9 trillion downgraded in FY2018. However, the upgraded quantum was higher than the downgraded quantum. At CARE, they have a “modified credit ratio", which for 2018-19 came in at 0.95 compared with 1.08 in 2017-18. CARE defines MCR as the ratio of (upgrades and reaffirmations) to (downgrades and reaffirmations). This ratio has been positive i.e. more than 1 over the previous five years. In FY19, though it is negative i.e. less than 1, it is not as deep into negative. In 2012-13, it was 0.81.
Thirdly, though banks are reeling under NPAs (non-performing assets), there is improvement in recovery rates and incremental slippages i.e. additional bad debts are lower than earlier. The Crisil report states that incremental slippages in the second half of FY19 was lower at 3.7% against 3.8% in the first half of FY19 and significantly lower than the average 6% of FY17 and FY18.
To summarize the rating action of the three agencies in FY19, it is either positive or a little negative, but overall it conveys a comfortable situation. What has been disturbing us is the downfall of or stress in certain non-banking finance companies (NBFCs). The sector is facing a challenge; growth is lower than earlier and funding is difficult i.e. cost is higher than earlier due to the headwinds. Asset-liability mismatch i.e. funding long-term with short-term sources has always been an issue with NBFCs, only that it has been highlighted after the IL&FS debacle. In 2008, after the global financial crisis, the Reserve Bank of India opened a special funding window for NBFCs, which has not happened this time. If the funding issue of NBFCs persists for some more time, the government or regulator will be expected to step in with succour, so that the broad economy is not impacted.
Net-net, you need not despair on your fixed-income-oriented investments. Hopefully, more issues should not break out and, gradually, this phase shall pass and the car will stop sputtering.
Joydeep Sen is founder, wiseinvestor.in