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Default rate at ten year high of 3.4% - CRISIL

Credit quality pressures have intensified for India’s corporates in 2011-12. Instances of default by CRISIL rated entities increased to 188, the highest for any year. The annual default rate for CRISIL-rated entities has hit a ten year high of 3.4% in 2011-12. These pressures are also reflected in the increase in banks’ gross nonperforming assets (NPAs; to 2.9% of advances from 2.3%) and in the quantum of debt restructured (to 3.3% of advances from 2.5%) between March 31 and December 31 of 2011.

Downgrades exceeded upgrades in the second half of 2011-12 as CRISIL downgraded 292 ratings and upgraded 266 ratings. This marked a reversal in trend from the first half of 2011-12 when CRISIL upgraded 313 ratings, which was higher than the 207 downgrades. The downgrades were driven by liquidity pressures and weakening demand. Significantly, one third of the downgrades were to the default category (‘CRISIL D’). Weak liquidity caused by elongation of working capital cycles is the primary reason for the defaults. This trend is likely to persist with slowing demand.

Highly indebted industries, including textiles, steel, construction and engineering, accounted for a fourth of the defaults. Textile exports have been hampered by weak demand, especially in the Eurozone. Steel manufacturers have had to contend with higher input prices. Industries dependent on investment demand such as construction and engineering, and industrial machinery have been affected by weak domestic demand, stretched working capital cycles, and high interest rates.

CRISIL’s rating action ratio (RAR; an indicator of relative frequency of upgrades and downgrades) declined to 1.01 times in 2011-12 from 1.10 times in the previous year. The decline has been in line with CRISIL’s expectations. The credit quality of India’s corporates will remain under pressure, given the slowdown in demand. However, high operating rates, softening in commodity prices and flexibility to defer capital expenditure will help players offset profitability pressures, and tackle slackening in demand. CRISIL expects RAR to decline further to less than 1 time over the near term. Higher rated (‘CRISIL AAA’ and ‘CRISIL AA’) companies have stronger balance sheets, and are, therefore, better positioned to withstand slackened demand. The extent of demand slowdown, access to funding, and degree of recovery in the global economy will be key monitorables over the medium term.