Are debt-ridden corporates the Achilles' heel of Indian economy?

Despite the significant positive turn in the outlook for India’s growth, stirred by a clutch of policy initiatives announced by the Modi-led government, a growing debt pile-up of corporates is cited as a reason for the argument that much of recent euphoria surrounding the country’s resurgence is yet to be translated to palpable gains.

Measured by debt-to-equity ratios, historically Indian firms are known to be heavier borrowers compared with those in other emerging market except Brazil, according to a recent report by IMF. The report expressed concern that Indian banks will not be able to fund fresh investment because they are weighed down by bad loans.

A major chunk of non-performing assets (NPAs), which are rising and continue to saddle the country’s financial system, is owed by companies. These NPAs include ‘restructured assets’—loans whose terms have been rejigged to make payment easier. These loans remain ‘bad’ even after terms have been restructured points to the depth of the malaise (a significant portion of restructured loans indeed turns bad). The problem is bigger among public-sector banks, which account for more than 70 per cent of the loan volume.

According IMF, a third of the corporate debt in India has a debt-to-equity ratio of more than three, the highest degree of leverage in the Asia-Pacific region. A high debt-to-equity ratio indicates that a corporate has been borrowing to fund expansion instead of raising money from the market. This can hamper its health if interest rates rise and economic growth falters.

Though the debt owed by the highly leveraged companies in the country is small relative to the overall size of the economy, it is still a concern.

During the fag end of the UPA regime, high interest rates, delayed project approvals, slowing demand and weak economic growth hampered the ability of corporate borrowers to repay debt. Though growth momentum picked up perceivably, going by the surging NPAs, health of corporates in the country is far less than impressive.

According to another report by Credit Suisse, collective debt worth more than $400 billion is held by over 4,000 Indian firms.

High corporate debt also poses a fundamental risk as it is widespread among sectors such as power, infrastructure, textiles and road which can affect exports as well as employment. To confound the problem, about half of the corporate debt is owed by companies with return on assets—earnings generated by a firm from its invested capital—below 5 per cent.

Also, a sizable share of debt is owed by firms with profit-to-interest expenses ratio of less than one (the lower the ratio, the more the firm is burdened by debt). An interest coverage ratio of less than 1 points to the fact that the firm is not generating sufficient revenue to repay interest on loans.

Though possible culpability of senior officials of many public sector banks and motivated actions of bank employees are cited as a key reason for the rising corporate debt, bad loans are an outcome many factors including non-performing administration, weak scrutiny by central and state governments and lack of oversight by policymakers and regulators.

To get a perspective, gross bad debt of 40 listed banks surged to Rs 2.43 trillion by December 2013, rising 36 per cent from a year earlier. NPAs of public sector banks rose 95 per cent between 2010 and 2012—the bulk of these bad loans were from the top 30 defaulters for most public sector banks.

Though banks, especially private ones beefed up diligence on bad loans—many private lenders have set up separate expert panels to monitor and contain NPAs over the last one year—debt is still a drag around lenders’ neck. Poor project appraisal techniques, lack of accountability and post-disbursal supervision led to a huge portion of this burden being borne by public sector banks.

According to another report, 10 corporate groups, including Adani, Vedanta, GMR, GVK and Jaypee together account for around 13 per cent of all banking system loans in the country. In other words, the Indian banking system is heavily exposed to the fortunes of just a few default-prone corporates.

As the Modi-led government is intensifying its campaign to attract investments into the country to fuel the pace of economic growth; policymakers, regulators and managements of banks and corporates should collectively take initiatives to pull corporates out of the mounting debt pile-up.