Rupee at 65: India Inc in a debt trap just when money is tighter

rupeeVivek Kaul 
During the past few months I have often pointed out the economic mess that the Congress led United Progressive Alliance (UPA) government has landed us into. But that is not the only mess going around. Corporate India is in an equally messy situation on the debt that it has managed to accumulate over the last few years.
Analysts Ashish Gupta, Kush Shah and Prashant Kumar of Credit Suisse in a report titled 
House of Debt – Revisited, dated August 14, 2013, put out numbers showing the same. They estimate that the gross debt of ten Indian corporate groups for the financial year 2012-2013 (i.e. the period between April 1, 2012 and March 31, 2013) stood at Rs 6,31,024.7 crore. Their debt has risen by 15% over the financial year 2011-2012 (i.e. the period between April 1, 2011 and March 31, 2012).
Interestingly, in the financial year 2006-07( i.e. the period between April 1, 2006 and March 31, 2007) the gross debt of these groups had stood at Rs 99,300 crore. So their debt has increased six fold in the period between March 31, 2007 and March 31, 2013.
And this has landed these groups (which include the likes of Videocon, Adani, Essar, JSW, Reliance ADA, Vedanta, GMR, GVK etc) into serious trouble. The overall interest coverage ratio of these groups as on March 31, 2013, stands at 1.4. The interest coverage ratio is essentially a measure of the capability of a company to pay interest on its outstanding debt. It is calculated by dividing a company’s earnings before interest and taxes (EBIT or operating profit) for a year by the interest to be paid on the outstanding debt for the same year.
An interest coverage ratio of 1.4 essentially means that for every Rs 1 of interest that the company has to pay, it makes Rs 1.4 of operating profit. This basically means that around 71.4%(1/1.4) of the operating profit of the ten groups cited in the report, will go towards interest payment. This is a very tricky situation to be in.
The interest coverage ratio of the ten corporate groups cited in the report has dropped from 1.6 as on March 31, 2012, to 1.4 as on March 31, 2013. What this means is that as on March 31, 2012, these groups would have had to pay 62.5% of their operating profits to pay interest on their oustanding debt. That has now jumped to 71.4%.
In fact, some of the groups have an interest coverage ratio of less than one. This basically means that they are not making enough money to repay the interest on their debt. As the Credit Suisse analysts point out “Aggregate interest cover for these top ten groups has dropped from 1.6x to 1.4x. Interest cover ratios at groups such as Essar, GMR, GVK and Lanco are already under 1. Interest cover at Adani and Jaypee have also fallen to <1.5x. Interest coverage ratio has come down from 1.2x to 0.6x for Lanco Infratech…Similarly, for GVK infra, the coverage ratio has come down from 1.0x to 0.4x.”
In fact the situation gets much worse if one takes into account the fact that the groups are currently not expensing the entire interest cost in their profit and loss account. This is because the money raised through debt has been used to construct projects. A large part of these projects are currently under construction and haven’t come on stream. Hence, a lot of interest is currently being capitalised, which basically means that it is being shown on the asset side of a balance sheet and hasn’t been shown as an expense in the profit and loss account.
As the Credit Suisse analysts point out “ As most of these groups have capacities under construction, a large share of interest expense is also currently capitalised. With capitalised interest currently 30- 250% higher than the P&L expense, the interest burden may also sharply rise as projects come on stream.”
Take the case of Reliance Power. The company is currently showing an interest of Rs 580 crore in its profit and loss account. At the same time the company has a capitalised interest of Rs 1470 crore. Once this interest moves from the balance sheet to the profit and loss account, the interest coverage ratio of the company will fall from 2.4 to 0.7. This basically means is that the company will not make enough of an operating profit to pay the interest on its outstanding debt.
The depreciating rupee has been adding to the problem because a huge proportion of the oustanding debt of these corporate groups is in foreign currency. “Many corporates’ loans are 40-70% foreign currency denominated; therefore, the sharp depreciation in the rupee is adding to their debt burden. Adani Enterprise and Reliance Comm have the largest percentage of borrowings through forex loans,” write the analysts.
One dollar was worth around Rs 55 in mid May. Now it is worth around Rs 65. Hence, this means that these corporate groups will have to pay more rupees to buy dollars to repay their foreign currency loans.
India’s external debt as on March 31, 2013, stood at at $ 390 billion. Of this nearly 79% debt is non government debt. External commercial borrowings(ECBs) made by corporates form nearly 31% of the external debt. This is not surprising given that the Credit Suisse analysts point out that 40-70% of the loans of the 10 corporate groups that they studied are foreign currency denominated. As these loans mature in the time to come corporates will need dollars to repay them, and this will put further pressure on the rupee.
What makes the situation more scary is the fact that ECBs of $21 billion raised by corporates need to be repaid before March 31, 2014. Corporates which are in a position to repay earlier, will make a dash for it. This is primarily because as the rupee depreciates against the dollar, a greater amount is needed to buy dollars.
So if companies have idle cash lying around, it makes tremendous sense for them to prepay foreign currency loans. The trouble is that if a lot of companies decide to prepay loans then it will add to the demand for dollars and thus put further pressure on the rupee.
All this debt, also means that the situation can’t be good for Indian banks which have lent money to these corporate groups. As analysts Ashish Gupta and Prashant Kumar of Credit Suisse pointed out in report titled 
House of Debt and dated August 12, 2012, “Over the past five years, Indian banks have witnessed strong (20% CAGR) loan growth. However, this growth is increasingly being driven by a select few corporate groups. In FY12, over 20% of the incremental loans came from just ten groups. The total debt level of these ten (Adani, Essar, GMR, GVK, JSW, JPA, Lanco, Reliance ADA, Vedanta and Videocon) has jumped 5 times in the past five years (40% CAGR) and now equates to 13% of the total bank loans and 98% of the net worth of the banking system.” The situation could have only gotten worse for Indian banks since then.
Of course the question is how did the big Indian corporate groups land up in this mess? 
As a recent report in The Hindu Business Line points out “Between 2002-03 and 2007-08, private corporate investment as a percentage of India’s GDP rose from 5.7 to 17.3. Subsequently, it fell to 13.4 in 2010-11, but was still higher than the single-digit levels till the early 2000s. The above investment binge was significantly financed through large-scale borrowings, contracted with the confidence that the projects executed would generate sufficient returns to service the debts. Moreover, the large differential between domestic and overseas interest rates, besides the belief in a perennially strong rupee, emboldened corporates to increasingly resort to ECBs (external commercial borrowings).”
Interest rates in India over the last few years have been higher in comparison to interest rates abroad. This is primarily because the Reserve Bank of India had been raising interest rates to tackle inflation. At the same time the Western Central banks had been running easy money policies where they were printing and pumping money into the economy. With a surfeit of money going around interest rates abroad were thus lower, leading to the Indian corporates borrowing abroad rather than in India.
The government helped corporates in this borrowing binge. As 
The Hindu Business Line report cited earlier points out “All this was further actively encouraged by policy makers at the Finance Ministry, RBI and Planning Commission. Among other things, corporates were permitted to access up to $500 million of ECB under the ‘automatic approval’ route every year, which got subsequently enhanced to $750 million.”
But now with the rupee rapidly against the dollar, all this debt will end up creating huge problems for these overleveraged corporate groups. One way out of this mess is by generating money through the sale of assets that these groups have. The trouble here is that who do they sell to? As the Credit Suisse analysts pointed out in their August 2012 report “Given the high leverage levels, poor profitability and pressure from lenders, virtually all of the ten debt-heavy groups have initiated to divest part of their assets (cement plants/power/road projects). However, given that most of the domestic infra developers are already over-geared, demand for these assets may be limited.”
The chickens, as they say, will come home to roost for India Inc.
The article originally appeared on on August 23, 2013 

(Vivek Kaul is a writer. He tweets @kaul_vivek)