‘Profitability pressures won’t ease immediately’

As a rating agency,we are primarily concerned with the creditworthiness of a company - its ability to service debt.

Written by P Vaidyanathan Iyer | Published:March 2, 2009 11:11 pm

Roopa Kudva joined Crisil in 1992 and gradually rose to be its Managing Director and Chief Executive Officer in July 2007. Before taking over the reins two years ago,she was the company’s Executive Director & Chief Rating Officer,heading its ratings business. While she does not expect an overnight blowout,Kudva tells P Vaidyanathan Iyer that she does expect credit quality to deteriorate further from here.

•What do credit ratings say about the slowing down of the economy?

As a rating agency,we are primarily concerned with the creditworthiness of a company — its ability to service debt. A very good indicator exists for trends in corporate creditworthiness,and that is the ratio of upgrades to downgrades in ratings. Historically,we have seen that whenever the ratio is greater than one (more upgrades than downgrades),it is a good indicator that the economy is on an upturn. Conversely,when the ratio is less than one,it serves as a good lead indicator of worsening fundamentals within the economy and industry.

In FY99,the ratio reached an all-time low of 0.63. In September 1997,CRISIL had issued an alert that credit quality has peaked. The number had reached one and we saw it going down thereafter.

The point I’m making is that decline in creditworthiness is something that we have been talking about for some time now. Now,clearly that trend has accelerated. If you look at the nine months of this year starting April,we have done long-term rating downgrade of 45 companies and upgraded only two companies.

•Which sectors are facing rating downgrades? The worst-hit sectors in the downturn?

Real estate is among the most stressed. Sectors that are highly dependent on exports,such as textiles (most of the debt defaults that have occurred so far have happened from this sector) and gems and jewelleries,are also highly stressed. Other sectors that are very vulnerable because of funding and high-interest rates are commercial vehicles and automobiles. Some NBFCs (non banking financial companies) whose activities are concentrated on the capital markets have seen a business downturn. Metals,both ferrous and non-ferrous,have been affected because globally commodity prices have dropped. Commodity-related sectors such as shipping and chemicals will also be affected.

On the other hand,the least vulnerable sectors would be power,healthcare,pharmaceuticals,and telecom. Other sectors like cement will come somewhere in between.

•Given the way things have dramatically changed in the last six-seven months,how do you capture the trends?

We have greatly intensified our surveillance efforts because the environment is dynamic and is evolving very fast. We are keeping an eye on three parameters: the first is availability and cost of funding — a big issue a few months earlier but not so much now (say,compared to the situation in September-October 2008). The second issue is how severe is the demand slowdown. And the third is the currency. Currency affects export-oriented industries,import-dependent industries,and also industries dependent on commodities whose prices are determined by global markets.

•But is there a difference between the downturn of the 1990s and now?

On the positive side,the balance sheets of Indian companies are much stronger today. All those companies that survived the downturn of the late 1990s emerged stronger. Companies have accomplished a lot in terms of improving their working capital management,supply chain management,workforce rationalisation,and productivity gains. A crisis forces you to become more efficient. Take the IT industry as an example. Now that their revenues are plunging,companies are figuring out ways to cut costs.

The second positive,in my opinion,is the health of the banking system. It is good for two reasons. Most banks are well capitalised. Average Tier I capital ratio for Indian banks is 8 per cent,which is a strong number by global standards. Banks took advantage of good capital market conditions prevailing earlier to raise funds. The second reason is that due to declining interest rates,Indian banks made huge treasury gains. They used those profits to clear the hangover of bad loans. So they are sitting on fairly clean balance sheets. Due to the stresses that I spoke about earlier,you will see non performing assets going up. But that will be manageable. NPA levels currently are the lowest ever in ban-king history.

•Do you think the two stimulus packages have been good enough?

I am very much impressed by the speed with which the government has responded — in coming out with stimulus packages,and the response to the NBFC crisis. At the same time,I believe that all these measures will slow down the pace of decline,but will not take the economy up,because the global forces that are operational are too strong.

•Have the monetary measures taken so far proved sufficient?

The transmission of monetary signals takes a lot of time within our system. The decline in inflation that we started seeing a month ago,I would say,was the result of measures taken six months ago. Any monetary measures you implement,it takes one quarter if you are lucky,but in all likelihood two quarters. That’s the reality one has to keep in mind.

•Could the RBI have been more aggressive in cutting rates,etc?

For the Reserve Bank of India,it is always a question of which issue should it give greater priority to. The RBI is trying to manage inflation,interest rates and the currency exchange rate. The RBI has to behave based on its understanding of what is most pressing at that point of time. Look at what happened at the end of September and beginning of October when liquidity dried up. The RBI was trying to manage the exchange rate — it was trying to protect the rupee from severe swings.

One aspect is: have they done enough? And the other is: how have they done compared to their own track record of the past? Relative to that I think this time they have been much faster.

•What about the next financial year,from the ratings perspective?

Things will get worse before they get better,especially from the creditworthiness aspect. There is always a lag effect. Non-performing assets show up on a bank’s balance sheet after about 18 months. Those things have yet to play out. If you take the banking system as a proxy for the health of the financial system,things will get worse before they get better. I don’t see profitability pressures easing immediately. While I am not expecting an overnight blow-out,I do expect credit quality to deteriorate further from here.

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