Rating agencies make it clear, however, that the improvement was driven not so much by fundamentals, but due to measures such as loan moratoriums, RBI’s liquidity injections and credit guarantee schemes.
In uncertain times, trends in credit rating give perspectives on corporate health, at least for the rated firms, apart from MSMEs. A recently released report from CRISIL states that the overall annual default rate declined to 2 percent in 2020-21 from 4.5 percent in 2019-20. There were 116 defaults in 2020-2021, a figure that is relatively on the lower side. This is encouraging, given that 2020-21 was a pandemic-afflicted year. And the default rate pertains to all rated companies, not just the higher-rated ones. However, upon scratching the surface, it becomes clear that the improvement was driven not so much by fundamentals, but due to other reasons.
There was a loan moratorium from March to August 2020. A one-time-restructuring was allowed till December 31, 2020. Then, there was deferment of asset classification norms by the Reserve Bank of India (RBI), apart from Long Term Repo Operations (LTRO) and Targeted Long Term Repo Operations (TLTRO). Additionally, there was the Emergency Credit Guarantee Scheme, relaxation of default recognition norms for rating agencies by SEBI and NCLT were kept in abeyance till March 2021. The CRISIL report also states that in future, the overall default rate is likely to rise. The rationale given is that the pandemic-induced relief measures are time-bound. Moreover, in certain segments, the impact of the slowdown induced by the pandemic would manifest gradually, which may adversely impact the rating scenario in 2021-22.
A similar report from ICRA states that both FY2020 and FY2021 marked a sharp rise in the proportion of entities downgraded by ICRA (vis-à-vis the historical averages), but the rating action trends since November 2020 suggest that incremental downgrade pressures have ebbed. The proportion of rating upgrades also has been on the rise over the past two quarters – Oct-Dec 2020 and Jan-Mar 2021. There were only 44 defaults in ICRA’s portfolio during FY2021, compared to 83 in the previous year. ICRA echoes a similar sentiment as CRISIL’s, saying the lesser number of defaults was largely an outcome of the relaxation provided by the regulators to the credit rating agencies (CRAs) in terms of default recognition, besides the timely alternative funding availed by entities from lending institutions to manage their liquidity. On the outlook, ICRA is little positive, with the statement that the overall credit quality of India Inc. is on the mend.
Credit rating and default trends in FY2022 are anybody’s call, as this is the first time we had a pandemic of this proportion, but still managed a better year in terms of credit rating / defaults, albeit with help from the measures mentioned earlier. While risks of slippage exist in the medium term, it may not be as worse as indicated in RBI’s Financial Stability Report (FSR) released in January 2021. It was rather an interpretation in certain quarters of a part of the FSR. The part of the FSR we are talking about, on which there was a lot of discussion in the market, was RBI’s call of Bank NPAs ballooning from 7.5 percent in September 2020 to 13.5 percent in September 2021. There are two salient aspects of the FSR report we are discussing.
One, the NPA of banks, which is at 7.5 percent as on September 2020, in the baseline case, is projected to move up to 13.5 percent in September 2021. Two, the adverse scenarios are “stringent conservative assessments under hypothetical adverse economic conditions . . . model outcomes do not amount to forecasts.” To combine these two aspects of the report, i.e., to take middle path, the interpretation is not an attempt to forecast the NPAs as of September 2021, but a model-driven scenario for discussion purposes, which give us a sense of direction. The report also stated that the projected ratios are susceptible to change in a non-linear fashion.
What’s in it for debt investors?
To make sense of all this, we have to look from the perspective of the typical debt investor. Investments are usually not made in MSME instruments, unless it is bonds issued by a micro-finance institution where it is contingent upon the pool of individuals. Most investments are routed through mutual funds, and are executed after due diligence. What we have discussed above are apprehensions, and there is no cause for alarm. Investors should do their basic checks and go ahead with debt mutual fund investments. The other means of taking exposure is through direct bonds. The higher rated bonds have a track record of low defaults over a long period of time. In the broad corporate segment, there are sectors impacted relatively less severely and there are more stressed sectors. Investors have to either go through the mutual fund route or take judicious calls on direct bonds. A challenging year has been managed with support from the system, which can be expected in future as well.