The Rot in Bad Loans of India Inc.

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If there is one melody that has played out all through this year, it has been the mounting concerns over bad debts. Banks are witnessing losses on the back of provisioning of bad loans. The blame for this can be put on India Inc. The ability of Indian firms to pay interest on their loans have continued to deteriorate in the December quarter.

As per a recently released report by Credit Suisse, the share of debt of Indian companies having interest coverage ratio (ICR) less than 1 has increased to 41% in December quarter. This is as against 39% in the preceding quarter. Furthermore, the share of chronically-stressed firms - those with ICR less than 1 for four of the past eight quarters - rose to 33% from 29% in the preceding quarter.

The interest coverage ratio is used to determine how comfortably a company is placed in terms of payment of interest on outstanding debt. It is calculated by dividing a company's earnings before interest and taxes (EBIT) by its interest expense for a given period. For example, if a company has a profit before tax (PBT) of Rs 100 million and is paying an interest of Rs 20 million, its interest coverage ratio would be 6 (Rs 100 m + Rs 20 m / Rs 20 m). Therefore, the lower the ratio, the greater are the risks. An interest coverage ratio of close to 1 basically tells us that the company is making just about enough money to keep paying interest on the debt that it has. Clearly, a worrying situation. Ideally, the interest coverage ratio of a company should be over 1.5. However, that has not been the case for a long while now. If one has to examine, huge capacities are built on borrowed money by companies. And with the slowdown in the growth, companies are stuck in a debt trap. The problem has grown so deep that steps like cost cutting, refinancing and restructuring are unlikely to help.

How did this happen and who are impacted the most?

A slowdown in global economy brought in most of the troubles for Indian companies. Lower demand meant declining profits and a decline in profits has impacted their debt servicing ability.

Of the above data, major defaulters in the list of poor debt servicing ability are metal and infrastructure companies.

The slowdown in China has had a clobbering effect on the already leveraged metal companies in India. A drop in metal prices globally have hit their profitability and have rendered them incapable of servicing their interest costs.

On the infrastructure front, many projects are being shelved or stalled. This has automatically raised the cost of these projects, leaving the developers cash strapped.

What can be expected further?

If the trend continues, lenders will become aggressive in their recovery. If that is the case, companies, being the borrowers, will have little choice but to monetize their assets. Hence, the firms that can find the way out will be the ones willing and able to sell their assets. That said; such steps will not solve problems overnight. While the companies may find a way out of debt trap, unless investment cycle and demand in the economy revives, the businesses are unlikely to grow. To get out of low growth trap, India will need to speed up reforms, get rid of the bureaucratic delays and make India more investor friendly.

As for banks, there should be a checklist before disbursing loans to companies. Banks need to strengthen their internal control and risk management system. There should be a system for timely detection of NPAs. More importantly, an in-depth assessment of borrowers shall be carried out by bankers rather than simply focusing on interest income.

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