Debt-Strangled India Inc. Faces a Year of Reckoning

The road, as they say, was paved with good intentions: In an effort to improve the country’s woeful infrastructure, long seen as a drag on Asia’s third-largest economy, India Inc. has pumped billions of dollars into new power plants, roads, rail lines and airports over the past decade. The investment was largely financed with foreign-denominated debt, a choice that seemed reasonable enough as recently as 2010, when the Indian economy expanded by 9.3 percent in real terms and the rupee remained relatively strong. But it doesn’t seem so reasonable anymore.

India’s economic landscape has changed dramatically in just a few years — the country’s real GDP grew by just 5 percent last year. Over the past three years, the value of the rupee has fallen to historic lows against the dollar, and several of the large corporations that borrowed heavily to finance those much-needed projects are now struggling to pay the interest on that debt. The hangover from India’s corporate debt binge is only expected to worsen in the coming months as debt burdens continue to climb even as the profitability of conglomerates invested in the country continues to weaken, Credit Suisse warned in a report this month entitled “House of Debt – Revisited.” Total borrowings for 10 large corporate groups, which totaled just 1 billion rupees in 2007, rose six-fold through 2012 and are currently at 6.3 billion rupees in 2013. In the report, Credit Suisse India analysts Ashish Gupta, Kush Shah and Prashant Kumar reviewed the balance sheets of 10 large corporate groups: Adani Group, Essar Group, GMR Group, GVK, Jaypee Group, JSW Steel, Lanco Infratech, Reliance Anil Dhirubhai Ambani Group, Vedanta Resources and Videocon Industries. The conglomerates are involved in a wide variety of businesses ranging from energy to mining, transportation to engineering. And what they discovered wasn’t pretty. The analysts found that gross debt levels at the 10 companies had risen by an average of 15 percent over the past year, even as their profitability remained “under pressure” due to the deteriorating economy. GVK, Lanco and ADA each saw their debt levels rise a whopping 24 percent. “For most of the corporate groups, the debt increase even outpaced [that of capital expenditures]. Asset sales – key for de-leveraging for most of these – have still not taken off,” the analysts wrote. “The increasing stress is visible, with some loans of Lanco, JPA and Reliance ADA having already come up for restructuring.” As companies sink deeper into the red, their interest coverage ratios – a measure of a company’s ability to pay interest on outstanding debt – are declining. Credit Suisse found the aggregate coverage ratio (calculated by dividing earnings before interest and taxes by interest expenses) for the 10 companies had dropped from 1.6 to 1.4 over the past 12 months. The situation is particularly alarming for Essar, GMR, GVK and Lanco, all diversified industrial groups with interests in transportation, energy and mining. Those companies’ ratios have fallen below one, which means they aren’t generating enough cash flow to pay their debt service, let alone use it for other means. The future promises to be even worse. A large portion of interest costs on already-borrowed monies has been capitalized, which means the conglomerates won’t start expensing it until the relevant project – whether it be a solar power plant, a highway or airport – has commenced construction. “With capitalized interest currently 30-250 percent higher than the P&L expense, the interest burden may also sharply rise as projects come on stream,” the Credit Suisse analysts wrote. Reliance Power, for example, has expensed interest of 5.8 billion rupees ($84 million), but an additional capitalized interest of 14.7 billion rupees ($220 million). With capitalized interest included, the company’s coverage ratio falls from a healthy 2.4 to 0.7. If that sounds bad, then consider this: Many of these companies borrowed 40-70 percent of their debt in foreign currencies. As the value of the rupee has plummeted, the size of their debt in local terms has ballooned accordingly. So far this year, the value of the rupee has fallen by 25 percent versus the U.S. dollar. Consider Adani Enterprises, a unit of infrastructure giant Adani Group. The increase in that company’s debt liabilities as a result of the rupee’s depreciation in the year to March 2013 exceeded its full-year net profit. “With the rupee down 12 percent since March 2013, the liabilities on account of this must have increased further,” the Credit Suisse analysts cautioned. Credit Suisse said the 10 companies in the report could face a “year of reckoning” in 2014. Debt repayments will be 30-150 percent higher in fiscal 2014 and repayments due at 2-18 times their fiscal 2013 profits. So it seems quite likely that banks will have little choice but to refinance or restructure at least some of the loans. All of this makes Credit Suisse wary of the Indian banking sector, which has already seen non-performing loans (NPLs) rise from 2.5 percent to 4 percent of loans as small and medium-sized enterprises struggle to make ends meet in the face of crumbling consumer spending. To this point, non-performing-loans among larger corporate borrowers have remained low. But that’s about to change for the worse. Much worse