Abstract
This Selected Issues paper examines how surges in global financial market volatility spill over to emerging market economies (EMs) including India. The results suggest that a surge in global financial market volatility is transmitted very strongly to key macroeconomic and financial variables of EMs, and the extent of its pass-through increases with the depth of external balance-sheet linkages between advanced countries and EMs. The paper also looks at food inflation, which has often been singled out as a key driver of India’s high and persistent inflation.
India’s Corporate Sector: Health and Profitability1
Despite recent gains in Indian equity markets, and an improved macroeconomic picture given robust capital inflows and a much-reduced current account deficit, based on four common indicators of corporate financial conditions (interest cover, profitability, liquidity, and leverage), a historically-high share of corporate debt is still owed by firms with relatively weak financials. Stress tests of corporate balance sheets derived from four economic shocks (domestic and foreign interest rates, the exchange rate, and profits) demonstrate continuing high vulnerabilities. Profit margins are also positively correlated with future investment, suggesting that more business investment will need to be accompanied by improvements in profitability.
1. The first decade of the 2000s was a period of robust economic expansion, accompanied by a 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. As a consequence, primary market equity issuance became an important means of financing for Indian corporations (see Oura 2008).
Primary Market Issuance in India
(In billions of Indian rupees)
Citation: IMF Staff Country Reports 2015, 062; 10.5089/9781498316200.002.A008
Sources: SEBI; and IMF staff calculations.2. With profitability rising, capital investment increased, particularly in the last few years before the global financial crisis (GFC) of 2008. Both median profit margins and investment increased substantially starting in 2003, reaching a peak in 2007. After a recovery in 2010–2011, both variables declined to levels roughly where they started out in 2003.
Profit Margin and Investment
(Percent) 1/
Citation: IMF Staff Country Reports 2015, 062; 10.5089/9781498316200.002.A008
Source: CMIE, IMF staff.1/ Based on a sample of 762 firms.3. However, in recent years, various indicators of corporates’ financial health have deteriorated. Domestic credit to corporates continued to rise prior to and after the GFC, driven by growth in lending by public banks, mostly for infrastructure projects. In addition, external commercial borrowings (ECBs) rose by 107 percent between March 2010 and March 2014. Corporate leverage also increased as the equity market saw relatively few issuances following the GFC, and stock price performance was tepid. As a result, the (capital-weighted) mean ratio of debt to equity for Indian nonfinancial companies increased from 40 percent in 2001 to 81 percent in 2013. Indian corporates are now among the more leveraged when compared with their emerging market (EM) peers, with quite large cross-sectoral differences in leverage across sectors—specifically in manufacturing and construction. In addition, greater external funding has exposed Indian corporates to external shocks, as they rely on foreign sources for more than one-fifth of their debt financing (primarily through external commercial borrowings (ECBs), trade credits, and bonds). This increased exposure to non-rupee debt has led to large foreign currency repayment obligations by India’s corporates.
Leverage Ratio for Indian Non-Financial Corporates
(Capital-weighted mean ratio of debt-to-equity)
Citation: IMF Staff Country Reports 2015, 062; 10.5089/9781498316200.002.A008
Source: IMF, Corporate Vulnerability Utility.Corporates: Median Debt to Equity
(In percent)
Citation: IMF Staff Country Reports 2015, 062; 10.5089/9781498316200.002.A008
Sources: IMF, Corporate Vulnerability Utility.Foreign Currency Debt Payments
(In billions of US dollars)
Citation: IMF Staff Country Reports 2015, 062; 10.5089/9781498316200.002.A008
Sources: Dealogic; and IMF staff calculations.4. The weakening of corporate balance sheets and diminished profitability is being reflected in market-based indicators of credit risk, and increased rates of stressed assets on banks’ balance sheets. On the positive side, default probabilities as estimated by Moody’s KMV,2 after a three-year period of increasing (particularly in the tail of the corporate default distribution), have come down since the spring of 2014. However, this is likely to be more a function of higher stock prices and reduced equity volatility, rather than a reflection of improved economic fundamentals. Evidence of corporate India’s worsening financial performance is found in the rising share of stressed loans in banks’ portfolios—both non-performing assets (NPAs) and restructured loans have continued to increase, and are at their highest levels since 2003.
Stressed Loans in India’s Banks
(In percent)
Citation: IMF Staff Country Reports 2015, 062; 10.5089/9781498316200.002.A008
Sources: RBI; and IMF staff estimates.1/ Foreign bank data for Q2 2014/15 are estimated.Expected Default Frequencies of Indian Corporates
(In percent)
Citation: IMF Staff Country Reports 2015, 062; 10.5089/9781498316200.002.A008
Sources: Moody’s KMV and IMF staff calculations.5. We follow Lindner and Jung (2014) and 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. An ICR below one does not indicate that insolvency is imminent. Firms can have investments that can be made liquid, unused credit lines, or other sources of funding which could assist them in remaining solvent.3
6. Based on these four indicators, we find that corporate stress in India is at present 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 through 2012/13, while stabilizing in the last year. The percentage of debt owed by loss-making firms reached 23 percent in 2013/14. Indian companies whose leverage exceeds two (that is, debt exceeds twice equity) account for more than 31 percent of borrowing by Indian corporates.
Interest Cover, Profitability, Liquidity and Leverage for Major Indian Non-Financial Corporates:
Share of Debt below/above Thresholds
EBITDA / Interest expenses
Profit after tax / Sales
‘Current Ratio’ = Current assets / Current liabilities
‘Debt Equity Ratio’ = Debt / Equity
Interest Cover, Profitability, Liquidity and Leverage for Major Indian Non-Financial Corporates:
Share of Debt below/above Thresholds
| ICR (<1) 1/ | Profitability (<0) 2/ |
Liquidity (<0.5) 3/ |
Leverage (>2) 4/ |
|
|---|---|---|---|---|
| (percent of total borrowing in sample) | ||||
| 1988/89 | 3.2 | 31.7 | 0.0 | 12.6 |
| 1989/90 | 1.7 | 7.3 | 0.0 | 19.8 |
| 1990/91 | 4.5 | 7.3 | 2.1 | 35.6 |
| 1991/92 | 1.5 | 11.8 | 7.7 | 20.1 |
| 1992/93 | 8.1 | 13.1 | 7.0 | 15.6 |
| 1993/94 | 9.4 | 11.0 | 7.4 | 23.6 |
| 1994/95 | 2.2 | 8.4 | 8.5 | 10.9 |
| 1995/96 | 6.8 | 8.3 | 6.0 | 9.7 |
| 1996/97 | 5.4 | 8.1 | 7.2 | 22.7 |
| 1997/98 | 8.7 | 13.4 | 6.8 | 28.5 |
| 1998/99 | 17.9 | 27.1 | 8.9 | 30.1 |
| 1999/00 | 17.9 | 26.7 | 8.4 | 28.7 |
| 2000/01 | 8.8 | 27.6 | 7.4 | 26.2 |
| 2001/02 | 15.5 | 27.6 | 6.3 | 28.1 |
| 2002/03 | 11.2 | 24.0 | 6.4 | 27.0 |
| 2003/04 | 4.5 | 11.6 | 5.7 | 18.7 |
| 2004/05 | 5.3 | 6.8 | 7.0 | 13.1 |
| 2005/06 | 3.0 | 4.9 | 7.8 | 16.1 |
| 2006/07 | 3.4 | 3.8 | 5.9 | 17.9 |
| 2007/08 | 2.6 | 7.2 | 13.2 | 17.0 |
| 2008/09 | 5.8 | 13.6 | 11.0 | 23.4 |
| 2009/10 | 4.2 | 8.3 | 14.8 | 21.2 |
| 2010/11 | 6.3 | 12.9 | 9.1 | 20.7 |
| 2011/12 | 7.8 | 17.0 | 12.1 | 28.0 |
| 2012/13 | 16.3 | 22.4 | 19.2 | 31.3 |
| 2013/14 | 13.8 | 22.9 | 21.3 | 31.4 |
EBITDA / Interest expenses
Profit after tax / Sales
‘Current Ratio’ = Current assets / Current liabilities
‘Debt Equity Ratio’ = Debt / Equity
Interest Cover, Profitability, Liquidity and Leverage for Major Indian Non-Financial Corporates:
Share of Debt below/above Thresholds
| ICR (<1) 1/ | Profitability (<0) 2/ |
Liquidity (<0.5) 3/ |
Leverage (>2) 4/ |
|
|---|---|---|---|---|
| (percent of total borrowing in sample) | ||||
| 1988/89 | 3.2 | 31.7 | 0.0 | 12.6 |
| 1989/90 | 1.7 | 7.3 | 0.0 | 19.8 |
| 1990/91 | 4.5 | 7.3 | 2.1 | 35.6 |
| 1991/92 | 1.5 | 11.8 | 7.7 | 20.1 |
| 1992/93 | 8.1 | 13.1 | 7.0 | 15.6 |
| 1993/94 | 9.4 | 11.0 | 7.4 | 23.6 |
| 1994/95 | 2.2 | 8.4 | 8.5 | 10.9 |
| 1995/96 | 6.8 | 8.3 | 6.0 | 9.7 |
| 1996/97 | 5.4 | 8.1 | 7.2 | 22.7 |
| 1997/98 | 8.7 | 13.4 | 6.8 | 28.5 |
| 1998/99 | 17.9 | 27.1 | 8.9 | 30.1 |
| 1999/00 | 17.9 | 26.7 | 8.4 | 28.7 |
| 2000/01 | 8.8 | 27.6 | 7.4 | 26.2 |
| 2001/02 | 15.5 | 27.6 | 6.3 | 28.1 |
| 2002/03 | 11.2 | 24.0 | 6.4 | 27.0 |
| 2003/04 | 4.5 | 11.6 | 5.7 | 18.7 |
| 2004/05 | 5.3 | 6.8 | 7.0 | 13.1 |
| 2005/06 | 3.0 | 4.9 | 7.8 | 16.1 |
| 2006/07 | 3.4 | 3.8 | 5.9 | 17.9 |
| 2007/08 | 2.6 | 7.2 | 13.2 | 17.0 |
| 2008/09 | 5.8 | 13.6 | 11.0 | 23.4 |
| 2009/10 | 4.2 | 8.3 | 14.8 | 21.2 |
| 2010/11 | 6.3 | 12.9 | 9.1 | 20.7 |
| 2011/12 | 7.8 | 17.0 | 12.1 | 28.0 |
| 2012/13 | 16.3 | 22.4 | 19.2 | 31.3 |
| 2013/14 | 13.8 | 22.9 | 21.3 | 31.4 |
EBITDA / Interest expenses
Profit after tax / Sales
‘Current Ratio’ = Current assets / Current liabilities
‘Debt Equity Ratio’ = Debt / Equity
7. Indian corporates’ balance sheet vulnerabilities have increased since the GFC. While during FY 2013/14 the share of all debt owed by firms in the sample with an ICR below one fell (see Table), a stress test of Indian corporates’ balance sheets reveals a further increase in vulnerabilities. In this analysis, 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.4 While the baseline share of firms with an ICR below one in 2013/14 is lower than in 2012/13, the 2013/14 stress tests point to increased adverse effects for the domestic rate shock and the combined shock.5 This indicates that the recent low-growth environment, coupled with higher leverage, has made India’s corporates more vulnerable to adverse shocks. In particular, under the combined shock (when all four variables are shocked simultaneously) the share of debt affected increases from 15 percent in 2008/09—the height of the GFC—to over 31 percent in 2013/14. This indicates that in a comparison between 2013/14 and 2008/09, there is the potential for a doubling of the share of vulnerable corporates under a severe stress scenario (as represented by the combined shock). Equally as important, the table shows that the increase in the share of affected debt over the baseline—at 17.5 percent in 2013/14—is the largest increase in vulnerability since 2007/08.
Share of Debt of Companies with ICR <1
(In percent)
Citation: IMF Staff Country Reports 2015, 062; 10.5089/9781498316200.002.A008
Sources: CMIE Prowess; IMF staff calculations.India: Stress-Test Results on the Non-Financial Corporate Sector
India: Stress-Test Results on the Non-Financial Corporate Sector
| Baseline | Domestic | Foreign Interest | Profit | FX Shock | Combined | |
|---|---|---|---|---|---|---|
| Interest Rate | Rate Shock | Shock | ||||
| Shock | ||||||
| +250 bps | +400 bps | −25 percent | +29 percent | |||
| Share of debt of companies with ICR <1 in total corporate sector debt | ||||||
| March 2008 | 2.58 | 4.24 | 2.59 | 3.44 | 2.59 | 7.71 |
| March 2009 | 5.77 | 8.68 | 6.46 | 8.10 | 6.63 | 15.14 |
| March 2010 | 4.24 | 6.29 | 4.25 | 5.40 | 4.24 | 13.34 |
| March 2011 | 6.34 | 8.14 | 9.81 | 7.43 | 6.31 | 16.15 |
| March 2012 | 7.81 | 11.54 | 8.95 | 11.30 | 8.83 | 23.82 |
| March 2013 | 16.32 | 18.58 | 16.92 | 19.14 | 16.48 | 30.03 |
| March 2014 | 13.85 | 20.01 | 13.98 | 19.02 | 13.89 | 31.37 |
India: Stress-Test Results on the Non-Financial Corporate Sector
| Baseline | Domestic | Foreign Interest | Profit | FX Shock | Combined | |
|---|---|---|---|---|---|---|
| Interest Rate | Rate Shock | Shock | ||||
| Shock | ||||||
| +250 bps | +400 bps | −25 percent | +29 percent | |||
| Share of debt of companies with ICR <1 in total corporate sector debt | ||||||
| March 2008 | 2.58 | 4.24 | 2.59 | 3.44 | 2.59 | 7.71 |
| March 2009 | 5.77 | 8.68 | 6.46 | 8.10 | 6.63 | 15.14 |
| March 2010 | 4.24 | 6.29 | 4.25 | 5.40 | 4.24 | 13.34 |
| March 2011 | 6.34 | 8.14 | 9.81 | 7.43 | 6.31 | 16.15 |
| March 2012 | 7.81 | 11.54 | 8.95 | 11.30 | 8.83 | 23.82 |
| March 2013 | 16.32 | 18.58 | 16.92 | 19.14 | 16.48 | 30.03 |
| March 2014 | 13.85 | 20.01 | 13.98 | 19.02 | 13.89 | 31.37 |
8. Applying the same stress tests to the corporate data since FY 1988/89 suggests increased vulnerabilities of the firms in India’s corporate sector. Regarding the baseline, and the marginal effects of the domestic rate shock and the profit shock, the share of debt affected is the highest since 2002 (see text chart). In the case of the combined shock, the share of affected debt is at its highest level over the full sample period, meaning corporates’ financial health is likely to deteriorate in the presence of a potential slowdown in economic activity or adverse shock to global liquidity.
Stress Test Results
(Percentage point difference from the baseline)
Citation: IMF Staff Country Reports 2015, 062; 10.5089/9781498316200.002.A008
Sources: CMIE Prowess; and IMF staff calculations.9. Over the past decade, the sectoral composition of India’s commercial debt has also changed. Corporates in the manufacturing and construction sectors, plus the infrastructure sector, contributed notably to banks’ NPAs.6 Between 2002/03 and 2013/14 corporate debt increased by 428 percent for a sample of 762 firms; over the four years ending in FY 2008/09, it increased by more than 20 percent each year. The metals and machinery sector, as well as chemicals and related firms, have the highest share in total corporate debt. The construction, services, and metals and machinery sectors exhibited the fastest growth in corporate debt over the sample period.
India’s Corporate Debt by Sector
(in billions of rupees)
Citation: IMF Staff Country Reports 2015, 062; 10.5089/9781498316200.002.A008
Sources: CMIE Prowess and IMF staff calculations.Growth in India’s Corporate Debt
(2003–2014; in percent)
Citation: IMF Staff Country Reports 2015, 062; 10.5089/9781498316200.002.A008
Sources: CMIE Prowess; IMF staff.10. The discussion of Indian corporates’ performance in the post-GFC period often neglects profitability, despite profits representing the main objective of entrepreneurial activity. In India’s case, investment and profitability exhibit quite an amount of positive correlation. Considering our sample of 762 firms, we find that investment and profitability (lagged by one year) move together (text chart).7 Drawing the same chart for the chemicals industry shows a similar picture. The correlations between lagged profitability and investment are positive for all nine sectors, as well as for the medians of all firms (see text table). The results of a panel data regression of investment on the debt-to-equity ratio, the lagged debt-to-equity ratio, and the lagged profit margin show a highly significant (and positive) effect of the lagged profit margin on investment (see also Anand and Tulin (2014) and Selected Issues Chapter IX).
All Firms: PAT and Investment
Citation: IMF Staff Country Reports 2015, 062; 10.5089/9781498316200.002.A008
Sources: CMIE Prowess; IMF staff.1/ PAT=Profit after Tax/Sales, lagged one Year.2/ Investment= Change in Capital Stock/Capital Stock prior Year.Chemical Industry: PAT and Investment
Citation: IMF Staff Country Reports 2015, 062; 10.5089/9781498316200.002.A008
Sources: CMIE Prowess; IMF staff.1/ PAT=Profit after Tax/Sales, lagged one Year.2/ Investment= Change in Capital Stock/Capital Stock prior Year.Correlation of Lagged Median Profitability with Investments
(percent)
Correlation of Lagged Median Profitability with Investments
(percent)
| Animal & Food | Mineral Products | Textiles & Leather Products |
Chemicals, Plastic & Rubber |
Metals & Machinery Production |
Construction | Energy Generation |
Services | Others | All |
|---|---|---|---|---|---|---|---|---|---|
| 46.7 | 30.6 | 58.8 | 60.1 | 84.6 | 38.9 | 37.9 | 41.6 | 76.6 | 77.3 |
Correlation of Lagged Median Profitability with Investments
(percent)
| Animal & Food | Mineral Products | Textiles & Leather Products |
Chemicals, Plastic & Rubber |
Metals & Machinery Production |
Construction | Energy Generation |
Services | Others | All |
|---|---|---|---|---|---|---|---|---|---|
| 46.7 | 30.6 | 58.8 | 60.1 | 84.6 | 38.9 | 37.9 | 41.6 | 76.6 | 77.3 |
References
Anand, R. and V. Tulin, 2014, “Disentangling India’s Investment Slowdown,” IMF Working Paper WP/14/47 (International Monetary Fund: Washington).
Lindner, P. and S. Jung, 2014, “Corporate Vulnerabilities in India and Banks’ Loan Performance,” IMF Working Paper WP/14/232 (International Monetary Fund: Washington).
Moody’s, 2004, “MOODY’S KMV™ RISKCALC™ V3.1 UNITED STATES,” June 1. Available at: http://www.moodysanalytics.com/~/media/Insight/Quantitative-Research/Default-and-Recovery/04-01-06-RiskCalc-v3-1-US.ashx.
Oura, H., 2008, “Financial Development and Growth in India: A Growing Tiger in a Cage?” IMF Working Paper WP/08/79 (International Monetary Fund: Washington).
Oura, H. and P. Topalova, 2009, “India’s Corporate Sector: Coping with the Global Financial Tsunami,” India: Selected Issues, IMF Country Report No. 09/186 (International Monetary Fund: Washington).
Reserve Bank of India, 2014, Annual Report 2013/14, (Reserve Bank of India: Mumbai), August 21. Available at: http://www.rbi.org.in/scripts/AnnualReportPublications.aspx
Prepared by Peter Lindner.
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).
This analysis is based on data from the Prowess database of the Centre for the Monitoring of the Indian Economy (CMIE).
As in Lindner and Jung (2014), 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 of the rupee.
The approach here follows Lindner and Jung (2014) and is based on Oura and Topalova (2009).
Infrastructure, textiles, engineering, metals and related products, chemicals, and mining, made up 36 percent of NPAs as of March 2014 (see Reserve Bank of India Annual Report 2013/14).
The profit measure used is the median of after-tax margin, defined as profit after tax (PAT) over sales. Investment is the median of the year-over-year change in the capital stock divided by the capital stock one year prior.
