Performance of ICRA-assigned ratings in FY 2022 upgrades rise, driven largely by entity-specific factors

FPJ Web DeskUpdated: Friday, April 01, 2022, 12:16 PM IST
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As businesses and policymakers adapted to the challenges, and as the economic repair-work progressed, the incremental downside credit risks ebbed in FY2022, ICRA said. /Representative image |

The credit quality of India Inc. experienced a rebound in FY2022, on the heels of two consecutive years of pressures caused first by the slowdown in economic growth in FY2020 and then by the pandemic scarring in FY2021.

As businesses and policymakers adapted to the challenges, and as the economic repair-work progressed, the incremental downside credit risks ebbed in FY2022.

As a result, the instances of downgrades1 of ICRA-assigned ratings in FY2022 (at 184 entities) reflected a downgrade rate2 of a mere 6 percent. This was substantially lower than the recent high of 13 percent seen in FY2020 and the past 10-year average of 9 percent. In contrast, the upgrade rate3 of 19 percent, corresponding to upgrades of 561 entities, stood at a multi-year high visà-vis the past 10-year average of 11 percent.

The sectors that witnessed a relatively high rating activity in the just-concluded fiscal are tabulated below:

Sectors that witnessed a relatively high rating activity

Sectors that witnessed a relatively high rating activity | ICRA

A large majority of upgrades were driven by entity-specific factors rather than sectoral tailwinds. As an example, in the power sector, several upgrades were triggered by the alleviation of execution risks as the renewable energy projects concerned became operational, or because of the demonstration of a consistent PLF4 track record which reduced the uncertainty around operations. Further, several renewable energy entities in ICRA’s portfolio benefitted from a change in ownership and/ or fresh equity capital infusion—as institutional investor money pivoted with ‘green’ assets. Finally, the refinancing of loans at more favourable terms including a longer tenor and lower interest rates, also contributed to a few upgrades in the sector. Incidentally, the power sector also saw a substantially higher downgrade rate compared with the overall portfolio.

The liquidity concerns arising from delayed payments by the counterparties, i.e. the power distribution utilities was a standout reason for a bulk of the downgrades. Also, a few downgrades of solar power assets were induced by the declining trend in PLF caused by the solar module degradation.

Likewise, several upgrades in the real estate sector were triggered by fresh funds infusion by the sponsors and/ or a favourable change in the ownership (including the purchase of equity stake by strong institutional investors or the entity coming under the umbrella of a REIT5 ). Upgrades were also triggered by factors such as favourable refinancing, and asset monetization supporting a material reduction in debt. Most of the above upgrades were in the warehousing and the office leasing segments, which were relatively less disrupted by the pandemic. The ratings of select large and reputed residential property developers were also upgraded, specifically those that maintained a strong traction in sales and collections even as the broader market remained dull. In comparison, the downgrades in the sector mostly pertained to the residential real estate entities and retail malls.

Both the pharmaceuticals and the chemicals sector are highly stratified in terms of product, customer, segment, and geographic mix. This implies a lack of homogeneity and thus a general lack of commonality in the industry risk factors that could drive a rating change. Unsurprisingly, the drivers of upgrades in these two sectors were entity-specific factors like market share gains, product-specific features, and improvement in the cost structure.

The upgrades in the construction sector were driven by the rising order books of select entities that are benefitting from the various public investment projects in roads and railways, as well as a demonstration of healthy execution progress. The receivable cycle of these entities is also observed to be and expected to be broadly in line with the contractual terms. As for the engineering sector, the reasoning for the upgrades is somewhat similar as above, that is, a growing order book position with strong counterparties.

Several road assets, particularly those developed via the hybrid-annuity model (HAM), witnessed upgrades in FY2022 as they received the initial few semi-annuity payments, including the operations and maintenance payments from the authority viz., the National Highways Authority of India (NHAI), without any deductions, and in a timely manner. Empirical data suggests that for the road annuity/ road HAM assets, if no concerns are seen in the receipt of the initial few pay-outs from the authority, then the revenue risk gets largely mitigated. The achievement of this milestone, thus, was a key trigger for upgrades in this sector in FY2022 and is expected to be so going forward as well as more HAM projects get operationalised.

In the metals, textiles, and the hospitality sectors, industry-related factors (as opposed to entity-specific factors) dominated as the primary drivers of rating movements in FY2022.

The steel portfolio of ICRA saw a substantially high upgrade rate during the past fiscal driven by expectations of steady volume growth and the benefits of sustained elevated realizations—resulting in the industry’s balance sheet benefiting from a multi-year low financial leverage. Although the prices of coking coal and the iron ore (the key inputs that go into steel making) have hardened substantially following the Russia-Ukraine conflict, the OPBITDA/ tonne of the industry participants is expected to remain higher than the long-period average in the near-term because of the realization-related tailwinds.

The year FY2022 was an exceptionally strong year for the domestic cotton yarn spinners led by the high yarn realisations and strong double-digit exports, particularly to Bangladesh (which was a beneficiary of the restrictions posed by the US and the EU on Xinjiang cotton, the Chinese cotton variety). This, along with other favourable regulatory and market developments, supported the upgrades in the past fiscal and is likely to support the credit profiles of entities in the textiles sector (across segments) in FY2023 as well.

The hospitality sector continued to experience a high downgrade rate in FY2022 because of the persistent weakness in occupancies and Average Room Rates (ARRs), being one of the sectors that has been most badly hit by the pandemic. However, in March 2022, ICRA revised its outlook on the sector to Stable from Negative. ICRA estimates that in the near-term, the revenues of the branded hospitality chains/ branded standalone properties would move much closer to the preCovid period revenues (FY2020), as business travel recovery takes root and supplements the already improving leisure travel trendlines.

In the financial sector, in FY2022, ICRA upgraded the ratings of the senior debt securities issued by four banks following the improvement in their solvency profiles which was expected to be sustained. ICRA also upgraded the rating of the Additional Tier-1 bonds of a public sector bank as it set-off its accumulated losses against the share premium account in line with regulations and enhanced its ability to service these bonds. In the NBFC space, ICRA upgraded the ratings of select retail NBFCs, microfinance institutions, and housing finance companies following their track record of maintaining a steady growth in the assets under management, resultant improvement in operating efficiency, and prudent liquidity management6

Currently, ICRA has a ‘Positive’ outlook on the following sectors: Metals, Oil & Gas (Upstream), Roads (Toll), and Textiles (Cotton Spinning). And the following sectors are on a ‘Negative’ outlook: Airlines, Airport Infrastructure, Media (Exhibitors), Power (Thermal), and Power (Distribution).

As the above commentary suggests, most corporate sectors are on a path to recovery. Further, there exist additional opportunities in sectors like steel, agricultural produce, textiles, and electronics goods to scale up exports. The ProductionLinked Incentive (PLI) Scheme too promises to enhance the supply chain resilience, support import substitution, and create other positive externalities. At the same time, banks as well as Non-Banking Finance Companies (NBFCs) are currently comfortably capitalised while facing manageable asset quality pressures. In effect, with both the real sector and the financial sector in a relatively good health, the year FY2023 could well have been a year of moving beyond the ‘rebound’ growth, but for the ongoing geo-political tensions.

Following the Russia-Ukraine conflict, the risk of supply chain disturbances and the commodity price turmoil have raised the spectre of inflation across the globe. As policy rates, risk premia, and bond yields adjust on the upside, the capital flows search for safe havens, and currencies find their equilibrium, the policymakers and regulators would be induced to take centre stage as they attempt to strike a balance between growth and inflation. If the military conflict is protracted or escalates, grappling with the challenge of rising input costs, energy costs, shipping and other logistics costs, besides potential supply disruptions would continue for businesses. This could quickly translate into asset quality pressures for the financial sector.

Considering the above factors, ICRA has revised its forecast for India’s real GDP growth in FY2023 to 7.2 percent from 8.0 percent. The inflationary pressures are likely to compress disposable incomes, constraining the demand revival. An early kick-off of the Government of India’s (GoI’s) budgeted capex programme would be helpful to boost investment activity in H1 FY2023.

However, a considerable portion of the step-up in the GoI’s budgeted capital spending is coming through the enlargement in the size of interest-free capex loans to the state governments to Rs. 1.0 trillion in FY2023 from Rs. 0.15 trillion in FY2022, shifting the execution responsibility on the latter. Regardless, a prolonged period of conflict and high commodity prices pose downside risks to the growth outlook, with margin compression set to squeeze the value-added growth during the period of the conflict. The possibility of resurgence of a debilitating Covid wave is also an unknown. While the credit quality of India Inc. has improved substantially over the past one year, there are looming risks which stoke scepticism and would warrant a careful monitoring of the operating environment as the new fiscal beckons.

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