IMF flashes warning signal on corporate leverage

The Indian government seems to have done well in the latest health check conducted by the International Monetary Fund (IMF) on the state of the economy.

Much of what the multilateral lender has said is unexceptionable: the authorities have done well to reduce external and budgetary deficits, tighten monetary policy to battle high inflation, shown renewed enthusiasm for structural reforms and tried to address market volatility. More needs to be done on these fronts to reduce the risk profile of the Indian economy—but the overall tenor of the report is not very different from what many other commentators have already pointed out.

The main emerging problems are actually to be found in the balance sheets of Indian companies and banks. The IMF has done well to publish a series of background research papers—what it calls Selected Issues—along with the new edition of its annual assessment of the Indian economy. One of the papers here gives us a good idea of how micro risks have been accumulating in recent years, as Mint also noted in its editorial published earlier this week about how corporate leverage is now the biggest threat to economic stability in India.

Indian companies have way too much debt. Leverage of non-financial companies has climbed since 2007. Banks continued to lend to companies—or were forced to because of the usual calls from New Delhi—after the global financial crisis. External commercial borrowings have soared. Indian companies now depend on foreign funding for a fifth of their debt finance. The IMF says that Indian companies are far more leveraged than their emerging market peers.

Much of these risks are concentrated in a smaller group of companies in certain sectors such as infrastructure and construction. The IMF has used four common indicators of corporate financial health—interest cover ratio, profitability, liquidity and leverage. It says that the financial health of Indian companies is at its worst in almost a decade. And their vulnerability to shocks such as higher interest rates or currency movements has climbed.

The upshot: the massive wave of deleveraging that took place in corporate balance sheets in the five years after 1998 has been undone in recent years.

The growing financial stress in company balance sheets has quite naturally begun to affect the health of the banks who have lent money to these companies. The recent troubles at United Bank of India could be a sign of a coming storm. Indian banks have seen their bad loans climb. They will need lots of capital to tackle their deteriorating loan books, fund future credit growth as well as meet the more stringent Basel 3 global rules on bank capital.

India is not out of the woods on the macro front: inflation is still high, growth is weak and fiscal pressures have not gone away. But these are issues that are well recognized. It is time the debate also encompasses the growing problems in the balance sheets of firms and banks. The IMF background papers offer enough data for us to worry.

 

onika jaiswal

pgdm 2nd sem

2013- 15

source -live mint