The CRISIL Ratings credit ratio (rating upgrades to downgrades) moderated to 2.19 times in the second half of fiscal 2023 from 5.52 times in first half of fiscal 2023.

Our Ratings Round-Up report for the first half of fiscal 2023 had presaged this because rising global inflation and the resultant interest rate hikes were expected to temper growth and weigh on the credit ratio.

In all, there were 460 upgrades and 210 downgrades across sectors in the second half.

While the upgrade rate fell ~320 basis points from the first half — and stood at 13.46% — it was still higher than the 10-year average (up to fiscal 2022) of 10%.

Says Gurpreet Chhatwal, Managing Director, CRISIL Ratings, “India Inc’s balance sheets have significantly strengthened and gearing levels continue to be at a decadal low. The median gearing of the CRISIL Ratings rated portfolio is expected be ~0.45 time as at fiscal 2024 end, marking a correction from fiscal 2023. This, along with steadfast domestic demand and the government’s unwavering focus on infrastructure spending, has kept the upgrade rate elevated.”

These reasons will lend a positive bias to the credit quality outlook of India Inc, going forward.

The downgrade rate, on the other hand, has gone up to 6.14% and almost reverted to its 10-year average rate.

“The downgrade rate has started reverting to its long-term averages. Volatile commodity prices have impacted profitability, particularly of micro, small and medium enterprises (MSMEs), while export-oriented sectors face headwinds from a slowdown in their major markets,” said Gurpreet Chhatwal.

MSMEs, which benefited from policy interventions during the pandemic, will now have to contend with higher input cost and increasing interest rates — just as repayments on restructured loans begin.

About 60% of the downgrades in the second half of fiscal 2023 were in the sub-investment grade category ,and these largely comprised MSMEs. As much as ~70% of the downgrades were because of a decline in profitability and/or liquidity pressure.

The third edition of CRISIL Ratings’ proprietary Corporate Credit Health Framework analyses operating cash flow strength (measured by expected change in absolute Ebitda) and balance sheet strength of the top 44 sectors for fiscal 2024 over fiscal 2023. These sectors account for ~70% of the rated debt (excluding the financial sector).

In the previous edition, the framework had indicated that export-oriented sectors will see cash flows moderating due to a slowdown in global demand. Unsurprisingly, the upgrade rate for export-oriented sectors halved to 12.2% in the second half of fiscal 2023 from 21.8% in the first half. The downgrade rate increased to 7.0% from 3.0%. However, some of the export-oriented sectors such as pharmaceuticals and electronic components continue to benefit from the Production-Linked Incentive scheme and increased global sourcing from India.

Key takeaways from the study for the second half of fiscal 2023:

• The most buoyant bucket has 19 sectors with favourable cash flows and robust balance sheets, accounting for 41% of the rated debt. Their operating cash flows are expected to grow over 10% on-year in fiscal 2024 led by volume growth even as commodity prices are softening. This segment includes sectors driven by domestic demand such as automotives and automotive components, hospitality and dairy products.
• The remaining 25 sectors will log favourable trends in one of the two parameters — operating profits or leverage — and hence their credit quality outlook will vary from positive to stable. These include some infrastructure sectors such as highway tolling, renewables and construction.

In the financial sector, we see balance sheets steadily improving for both banks and non-banking financial companies (NBFCs) because of better capitalisation, asset quality and profitability. Bank credit growth is expected to be ~15% in fiscal 2024, almost similar to the level expected in fiscal 2023, with corporate credit picking up on the back of rising capex. For non-banks, credit growth is expected at 13-14% in fiscal 2024 versus 12-13% in fiscal 2023, and will continue to be driven by the retail segment.

India’s banking system has been largely insulated from recent global events such as the near-collapse and subsequent rescue of a global bank, and the collapse of some regional US banks.

Says Somasekhar Vemuri, Senior Director, CRISIL Ratings, “Interest rate risk, the root cause of stress at some banks in the US, is relatively lower for Indian banks for three reasons. One, loans (~70% of deposits), a large part of which are at floating interest rates, dominate asset books, while investments, which are vulnerable to interest rate risks, account for lower share (~ 30% of deposits). Two, with base interest rates in India higher and rate hikes fewer, the sensitivity of investments to mark-to-market losses is relatively lower. Third, regulations currently allow banks to hold investments up to 23%¹ of net demand and time liabilities under the held-to-maturity category, which significantly shields them from interest rate movements.”

Upgrades are expected to outnumber downgrades in fiscal 2024 as well, albeit at a slower pace. Domestic consumption should continue its post-pandemic recovery trajectory, given India’s gross domestic product is expected to grow 6% in fiscal 2024 — the fastest among large economies, but slower than the 7% expected in fiscal 2023 as per CRISIL. While the CRISIL Ratings credit quality outlook has a positive bias, the undertone is of caution because the full impact of the interest rate hikes on domestic demand is yet to be seen and a higher-than-expected global slowdown could further impact exports. Also, tightening of global monetary conditions and depreciation in rupee could increase refinancing risk particularly for companies with sizeable maturing overseas debt, which will also be a close monitorable.

¹ As per RBI regulations, banks may have investments under the held-to-maturity category up to a limit of 23% of Net Demand and Time Liabilities (NDTL) till March 31, 2024. This limit is to then progressively reduce to 19.50% as on March 31, 2025. As per latest estimates, deposits constitute over 90% of NDTL of Indian banks.