Journal Issue

India: Selected Issues

International Monetary Fund. Asia and Pacific Dept
Published Date:
February 2014
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India’s Corporate Sector: Health and Vulnerabilities1

Since 2007, the leverage of India’s non-financial corporate sector has significantly increased. Based on four standard measures of corporate financial health – interest cover, profitability, liquidity, and leverage – a greater share of Indian corporate debt is owed by firms operating outside the critical boundary with regards to at least one of the four variables. Stress tests of the corporate balance sheets based on four macroeconomic shocks – to domestic and foreign interest rates, the exchange rate, and to profits – show the highest vulnerabilities to the individual shocks since 2002–2003, while exhibiting the highest susceptibility to the combination of all four shocks in the full sample.

1. The eight years before the global financial crisis (GFC) in 2008 were not only a period of notable economic expansion, but also of signicant strengthening of India’s corporate balance sheets. Between March 2001 and March 2008, the Bombay Stock Exchange (BSE) Index rose almost four-fold, while the value of BSE-listed equities increased nine-fold. On the back of that, primary market equity issuance became a major means of financing for Indian corporations. Together with the increase in profitability they experienced, leverage declined, particularly in the last few years before the crisis. Although domestic bank credit and external debt grew rapidly before the GFC, equity issuances increased even more, the market-to-book ratio of Indian corporates more than tripled between 2001 and 2006, and the interest cover ratio (ICR) more than doubled. Corporate India’s return on equity almost doubled over the same period.2

Primary Market Issuance in India

Source: SEBI, IMF staff

2. However, during the current slowdown, various indicators of corporates’ financial health have deteriorated. Domestic credit to corporates continued to rise during and after the GFC, driven notably by public banks’ loan provision, notably for infrastructure projects. In addition, external commercial borrowings (ECBs) have risen by 71 percent between March 2010 and March 2013. Corporate leverage rose as the equity market saw relatively few issuances after the GFC, and stock price performance was fairly lackluster. The (capital-weighted) mean ratio of debt to equity for Indian nonfinancial companies increased from 40 percent in 2001 to 83 percent in 2012. Indian corporates are now among the most leveraged when compared with their emerging market peers. Furthermore, overall leverage measures disguise substantial differences across sectors—specifically manufacturing and construction (sectors with concentrated lending to infrastructure and the power sector).

Leverage Ratio for Indian Non-Financial Corporates

(Capital-weighted mean ratio of debt-to-equity)

Source: IMF, Corporate Vulnerability Utility.

3. External corporate funding creates potential feedback loops between corporate vulnerabilities and external shocks. Indian corporates rely on foreign sources for more than one-fifth of their debt financing, including ECB, trade credits, and bonds. Not only has foreign financing grown, but ECBs have also become concentrated, with about a sixth of approved foreign loans going to only 14 large conglomerates (Credit Suisse, 2013). BIS data show that nearly two-thirds of India’s liabilities to BIS reporting banks are borne by nonbank companies, and much of that debt is short-term. In addition, debt service payments over the next two years are forecast to come in at higher levels than during the GFC, and their maturity profile has shortened. About 35 percent of ECBs are hedged with financial instruments, with the scope of ‘natural,’ business-related hedges difficult to estimate.

Corporates: Median Debt to Equity

(In percent)

Sources: IMF, Corporate Vulnerability Utility.

Debt Payments

(In billions of US$)

Sources: Dealogic and IMF staff calculations.

BIS Reporting Banks’ Foreign Claims on Selected Asian Economies by Sector 1/

(In percent of GDP)

1/ Claims are on ultimate risk basis. As of Q1 2013.

Sources: Bank for International Settlements; Haver Analytics; IMF, World Economic Outlook; IMF staff calculations.

BIS Reporting Banks’ International Claims on Selected Asian Economies by Maturity 1/

(In percent of GDP)

1/ Claims are on immediate borrower basis. As of Q1 2013.

Sources: Bank for International Settlements; Haver Analytics; IMF, World Economic Outlook; IMF staff calculations.

4. The deterioration in corporate balance sheets and profitability is being reflected in market-based indicators of credit risk, and increased rates of loans entering non-performing status. Default probabilities as estimated by Moody’s KMV3 have also begun to rise. Notably, even though the KMV default probability for the median firm remains below the levels reached during the GFC, the probability for the 90th percentile exceeds now the levels witnessed during the GFC, pointing to significant stress at the tail of the corporate default distribution. Corporate India’s worsening performance is reflected in the share of loans that enter NPA status (slippages), which are at their highest since 2003.

Indian Banks: Slippage Ratios

(In percent)

Sources: RBI

Expected Default Frequencies of Indian Corporates

(In percent)

Sources: Moody’s KMV and IMF staff calculations.

5. We gauge India’s corporate health based on four commonly used indicators: interest-cover ratio (ICR), profitability, liquidity, and leverage. ICR and profitability are dynamic indicators, assessing the degree to which current revenues are able to fund interest expenses, or whether a firm’s operations and financial activities are essentially self-funding, respectively. Both measures are essentially snapshots, taken at a particular point in time. An ICR below one, or a lack of profitability, does not indicate that insolvency is imminent. Firms can have investments that can be easily liquidated, unused credit lines, or other sources of funding which could carry them through. Other research has found, though, that the ICR in particular can be a good indicator of vulnerabilities—for example, Jones et al. (2006) found that stress testing applied to the balance sheets of Korean corporations in advance of the Asian crisis of the late 1990s would have shown the degree of financial vulnerabilities present in the country. In India’s case, a linear regression of the slippage ratio on the (lagged) share of debt of companies with ICR below 1 results in a coefficient of 0.24, implying an increase in slippages of 0.24 percent during period t for each percentage point increase in the share of debt owed by companies with an ICR below one at the end of period t-1. The R-squared of that regression is 80 percent, with an autocorrelation- and heteroscedasticity-corrected t-value of 5.3 for the slope parameter.

6. Based on these four indicators, we find that corporate stress in India is at its highest since the early 2000s. The table below suggests that the share of corporate borrowing accounted for by companies with extremely weak financial health indicators (ICR, profitability, liquidity and leverage) has increased. The percentage of debt owed by loss-making firms has reached 17.3 percent. Indian companies whose total debt exceeds five times equity account for more than 18 percent of the borrowing by Indian corporates. These four indicators of corporate health were at their best in FY 2005/06. On an aggregate measure of distress (using the mean absolute deviation of each of the four variables from their FY 2005/06 lows), corporate India’s financial health in 2012/13 was at its worst since FY 2002/03.

Interest Cover, Profitability, Liquidity and Leverage for Major Indian Non-Financial Corporates: Share of Debt of Firms below/above Critical Values
ICR (<1) 1/Profitability (<0) 2/Liquidity (<0.5) 3/Leverage (>5) 4/
(percent of total borrowings in sample)
Sources: CMIE Prowess; IMF staff calculations. Sample size about 900 firms.Note: Critical values are shown in parentheses.

EBITDA / Interest expenses

Profit after tax / Sales

‘Current Ratio’ = Current assets / Current liabilities

Total debt / Market capitalization

Sources: CMIE Prowess; IMF staff calculations. Sample size about 900 firms.Note: Critical values are shown in parentheses.

EBITDA / Interest expenses

Profit after tax / Sales

‘Current Ratio’ = Current assets / Current liabilities

Total debt / Market capitalization

7. Indian corporates’ balance sheet vulnerabilities to financial shocks have increased since the GFC. Against the backdrop of recent financial market pressures in India, a stress test analysis of Indian corporates’ balance sheets shows a significant increase in vulnerabilities. Specifically, four financial variables (domestic and foreign interest rates, profitability and exchange rates) were shocked individually and also jointly, and the shares of total debt owed by firms exhibiting an ICR below one were calculated for each of these five scenarios. Three of the four shocks are calibrated to the financial market developments during the summer of 2013, and to the change in profitability experienced in 2009. The shocks include: an increase in domestic interest rates by 250 basis points (bps); an increase in foreign interest rates by 400 bps; a decrease in operating profit by 25 percent; and a 29 percent depreciation in the rupee. Comparing baselines in 2007/08 and 2012/13, the debt owed by firms with ICR below one in 2013 is much higher than it was in March 2008. Moreover, the 2012/13 stress tests indicate significantly higher vulnerabilities than the stress tests for 2007/08.4 Also, over the past year, the vulnerabilities to all four shocks have increased—in particular to the domestic interest rate and the profitability shocks. This indicates that the protracted low-growth environment, coupled with higher leverage, has made India’s corporates notably more vulnerable. In particular, under the combined shock scenario (when all four variables are shocked simultaneously) the share of debt affected increases from 7.5 percent in 2007/08 to 27 percent in 2012/13. The combined shock scenario highlights Indian corporates increased vulnerability.

India: Stress-Test Results on the Non-Financial Corporate Sector

March 2013

Interest Rate

Foreign Interest

Rate Shock
ProfitsFX ShockCombined
+250 bps+400 bps−25 percent+29 percent
Share of debt of companies with ICR <1 in total corporate sector debt
Share of the number of companies with ICR <1 in total number of companies

Share of debt of companies with ICR <1

(In percent)

Sources: CMIE Prowess; IMF staff calculations.

8. Applying the same stress tests to the data since FY 2000/01 reflects the increased vulnerability of India’s corporates at the tails. For the domestic rate shock, and the profit shock, the share of affected debt is the highest since 2001; in the case of the combined shock, the share of debt is at its highest level over the full period (see table below). If a subdued economic outlook and global liquidity tightening combine going forward over a protracted period, further significant deterioration in corporate financial health, and subsequently higher restructured advances and NPAs, can be expected.

Stress-Test Results: India’s Non-Financial Corporate Sector
Baseline March 2013Domestic

Interest Rate


+250 bps
Foreign Interest

Rate Shock

+400 bps

-25 percent
FX Shock

+29 percent
Share of debt of companies with ICR <1 in total corporate sector debt
March 2000

March 2001

March 2002

March 2003

March 2004

March 2005

March 2006

March 2007

March 2008

March 2009

March 2010

March 2011

March 2012

March 2013

Sources: CMIE Prowess; IMF staff calculations
Sources: CMIE Prowess; IMF staff calculations

Prepared by Peter Lindner (MCM).

Oura (2008) provides an in-depth discussion of Indian corporates’ financial structure before the GFC.

Moody’s KMV is a model of default risk based on the Black-Scholes-Merton model, incorporating balance sheet and equity market data. See Moody’s (2004).

The approach here is based on Oura and Topalova (2009). Comparing the 2007/08 results here with theirs, we find that our baseline is far lower, but also that the increase in the case where an identical shock is used—25 percent decline in profitability—leads to a lower increase in the share of stressed firms. The main reason for this is likely our use of EBITDA rather than EBIT in the definition of ICR, as well as differing samples.

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