Saturday, December 26, 2015

India economy update

More disturbing signals about the Indian economy. The RBI's latest Financial Stability Report points to increased banking sector risks due to deteriorating asset quality and weak corporate performance. Asset quality, in terms of both Gross NPAs and restructured loans has been continuously worsening.
Much the same trend is mirrored in all the important indicators of banking health.
Interestingly, as a share of total sectoral exposure, aviation is the most vulnerable. Encouragingly, with lower fuel prices, sectoral competitiveness and profitability of the aviation sector would, in all likelihood, improve significantly in the years ahead.
An interesting feature of the firm size-wise credit allocation break-up is the dominance of large firms. But the disturbing trends are the share of stressed advances to large and medium scale enterprises, at 21% each. Given that large enterprises make up nearly 35% of all non-food credit, the high share of stressed advances is a matter of systemic concern. The equally high share of stressed advances to medium scale sector is likely to further deter lending to these types of firms, thereby reinforcing the forces that prevent greater credit inflows into a category of firms which are critical to driving job creation.   
The other, upstream, side of the banking sector balance sheet is corporate performance. The major share of the stressed assets, in terms of low interest coverage ratio and high leverage, is in the construction, power, iron and steel sectors. The graphic below highlights the performace of 2711 non-government, non-financial companies.
The Business Standard analysed the balance sheets of the country's top 441 indebted non-financial companies and found that 67 firms, with a total debt of Rs 56,500 bn at end 2014-15, had negative net worth or financially insolvent. This was an increase from 16 companies at the end of 2009-10. The total debt of these 441 companies was Rs 285,000 bn and accounted for 98.1% of the gross debt of 654 listed non-financial corporates. 
The analysis points to a negative feedback loop of falling profitability, rising interest costs, and falling investments, 
Return on capital employed (RoCE) for the indebted in the Business Standard sample declined to a decade-low 7.4 per cent in 2014-15, which was only a few basis points (a basis point is a hundredth of a percentage point) more than their average interest cost of 7.1 per cent. At this rate, many companies may be forced to default on their loans as profits from operations will be insufficient to cover the cost of debt servicing. The firms' interest cost on incremental debt is already trending higher than the underlying return on capital employed. In 2014-15, the cost of incremental debt shot up to 11.8 per cent, nearly 440 bps higher than the underlying return on capital employed. At its peak during the financial year 2004-05, these companies reported a return on capital employed of 18.7 per cent more than twice their average interest cost of 6.9 per cent.

The last financial year was also the first instance in a decade when companies' interest expenses were higher than depreciation. The indebted companies of the sample spent Rs 2.03 lakh crore on interest payments in 2014-15, up from Rs 1.83 lakh crore a year ago. In comparison, their depreciation allowance rose marginally to Rs 2.02 lakh crore from Rs 1.9 lakh crore in 2013-14. Thus, companies spent a greater part of their operating profits on debt servicing rather than capital expenditure and growth. In all, interest payments accounted for 34.2 per cent of the companies' operating profits in average last financial year, up from 16.7 per cent five years ago and 12 per cent a decade ago. This leaves little resources for growth capital.
This is a powerful deterrent to the revival of the investment cycle, essential to the creation of jobs. Worse still, it appears to be taking its toll on the existing jobs, as a recent series in the Indian Express, which also examined the situation in power and roads sectors, wrote
A look at the group of 230 leading companies listed on the Bombay Stock Exchange (BSE 500), and have an aggregate market cap of over Rs 55 lakh crore, shows that for the first time in at least four years they witnessed a decline in their aggregate employee strength as it fell by 14,000 in the year ended March 2015. While 105 out of the 230 companies reduced their headcount by an aggregate of 84,688 during the year, 114 companies within the list increased their staff strength by 69,910. For the remaining 11 companies, the numbers remained constant. The aggregate employee strength for these companies came down from 21.56 lakh in the year ended March 2014 to 21.41 lakh in the year ended March 2015... In Financial Year (FY) 2014 the same group of 230 companies added an aggregate of 1.63 lakh employees and in the three year period between FY’11 and FY’14 they added close to 4 lakh employees. However, the numbers fell in FY’15 as companies facing decline in revenue growth and low capacity utilisation resorted to laying off their employees. The biggest drop in number of employees during the year was witnessed by companies in manufacturing, construction and infrastructure, and capital goods, whereas IT and pharma companies saw net addition to their employee strength.
This trend, especially in those sectors which traditionally contribute to large job creation, does not portend well. 

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