Corporate India’s credit quality is showing early signs of recovery. This is indicated by Crisil’s credit ratio (ratio of number of upgrades to number of downgrades) of 1.64 times for the first half (H1) of 2014-15 (refers to financial year, April 1 to March 31). 

Upgrades exceeded downgrades in H1 2014-15, with 741 upgrades as compared to 451 downgrades. Firms with low debt exposure primarily witnessed positive trends in credit quality. Despite the credit ratio exceeding 1 time, the ratio of the quantum of debt of the firms upgraded, to that of those downgraded (excluding financial sector players) remained weak at 0.59 times during the same period, reflecting continued pressure on systemic credit quality. According to Crisil’s study, the improvement in credit quality will be gradual and any significant recovery will be contingent to a sustainable increase in investment demand.

The improvement in business-related factors was the key driver for 60 per cent of the upgrades. This is visible for export-linked sectors and non-discretionary consumer segments such as traders, packaged foods, pharmaceuticals, textiles and agricultural products, which continue to have the highest upgrade rates.

Firms with better profitability (return on capital employed [RoCE] exceeding 15 per cent), witnessed three upgrades for every downgrade. Among firms with low leverage (debt-to-earnings before interest, tax, depreciation and amortisation [EBITDA] ratio below 2.5 times), more than three firms were upgraded for every downgrade in H1 2014-15.

In contrast, weak liquidity, and pressure on profitability were key drivers for downgrades. Firms with high leverage (debt-to-EBITDA above 4 times) were subject to significant credit quality pressures as evident from their credit ratio below one during first half of 2014-15. Players operating in the construction, engineering and capital goods, and automobile (auto) ancillary sectors had higher downgrade rates than their counterparts in other sectors.

Crisil expects a gradual improvement in the credit ratio over the medium term, as economic growth records mild recovery from the lows of the two years through March 31, 2014. The impact of the monsoons, progress by indebted corporates in reducing their external debt through asset sales or equity infusion, demand outlook in the economy, and the extent of policy reforms by the Government of India, will remain key monitorables.