Corporates 25bps closer to default cliff: India Ratings

India Ratings & Research (Ind-Ra) says that the number of stressed corporates in BSE 500 may creep up to 10.7 percent from 9.5 percent (currently) from the 25bp increase in repo rate. The revised number accounts for 11 percent of the balance sheet debt of BSE 500 corporates. However, this is under the assumption that the 25bp increase in repo rate is translated into a similar increase in lending rates.

If the repo rate is increased by another 25bp in the next three months, the stress level may shoot up substantially, taking the number of stressed corporates to 13.1 percent and the amount of stressed debt to 16.5 percent from10.9 percent. This could unleash a second wave of restructuring and non-performing assets.

In absence of any rise in interest rates, the performance of BSE 500 corporates in H1FY14 suggests that even at the current level of economic activity defaults may have been peaking out. The number of corporates with a coverage ratio of 1.2x or below increased marginally to 16.6 percent in 1HFY14 from 15.3 percent in FY13 and the proportion of corporates in higher stress baskets (coverage ratio below 1.0x) reduced to 11.4 percent from 12.2 percent.

Given the pressure on emerging market currencies in the last few days, limited leeway exists in reducing rates. To the extent inflation does not reduce substantially, further rate cuts may be difficult to envisage. However given India's low real interest rate environment, which is estimated by Ind-Ra at 2.00 percentage points below the 2008 (pre-crisis level), further rate hikes may not be ruled out if the currency further weakens significantly.

Consumer price inflation remains stubbornly high. The likelihood of any moderation in inflation is low in the build-up to the general elections. In the event of adverse global developments, the Reserve Bank of India may have to choose between saving the rupee by enhancing the real interest rate or unleasing the second wave of corporate defaults, which may be much higher than default rates observed thus far.

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