Corporate credit quality continues to strengthen in H1 FY25 as upgrades outpace downgrades

Credit quality of Indian companies continued to strengthen in the first half of FY25 with the number of rating upgrades outpacing rating downgrades, half-yearly reviews by four credit rating agencies showed. The improvement was backed by strong domestic growth, revival in rural consumption, government's infrastructure push, and low corporate leverage levels.

The annualized upgrade rate of 14.5% outpaced the average of around 11% for the past decade, while the downgrade rate of 5.3% was lower than the 10-year average of 6.5%, Crisil Ratings said, adding the rating reaffirmation rate continued to be stable at around 80%.

Icra said around 50% of the rating upgrades were driven by the growth in profits supported by economies of scale, operationalization of projects reducing project risks, and other business-related factors. Only 10% of upgrades were triggered by industry tailwinds and pertained largely to the hospitality sector where supply additions continue to lag demand.

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“Another major driver of rating upgrades in H1 FY2025 has been the consistent trend in the de-leveraging of balance sheets,” Icra said, adding that despite incurring higher capex over the last five years, companies have been prudent in their funding mix and debt hasn’t risen in tandem with the capex expansion.

Crisil expects corporate gearing levels to remain healthy (below 0.5x) despite private sector capex showing signs of revival from the sharp decline seen during the pandemic.

Having burnt their fingers in the last round of capex boom fuelled by loans, corporates have been deleveraging over the last few years. Experts have pointed out that companies now rely more on internal accruals for capital expenditure, a move, while prudent, has hit demand for corporate loans from banks.

A sample of 2,488 companies from 25 sectors analyzed by rating agency Icra showed that financial leverage has declined across sectors. At an aggregate level for all these companies, leverage as expressed by the ratio of total debt to profit before depreciation, interest and taxes (PBDIT) stood at 1.8 in FY24, down from the peak of 3 in FY15 and again in FY20.

To their credit, banks have strengthened underwriting standards and are more selective in taking chunky loan exposures in projects.

Sectoral trends

“As many as 38% of the upgrades were from the infrastructure and linked sectors, driven by acquisitions by strong sponsors and lower than expected debt, particularly in the renewables sector, reduction in project risks as road projects achieve critical milestones, progressive order execution in construction and a healthy order book in the capital goods sector,” said Subodh Rai, managing director, Crisil Ratings.

On the other hand, downgrades were spread across sectors. Agricultural products saw some downgrades due to volatile realizations, whereas export-oriented sectors such as textiles and chemicals felt the impact of moderation in global demand.

Other downgrades, accounting for over 24% of the negative rating actions, pertained to entity-specific liquidity issues, particularly in companies in the sub-investment grade category, India Ratings said. Other factors included lower-than-expected or decline in orderbook, low demand from export markets, lower pricing and muted same store sales growth impacting revenues, it added.

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“The borrowing costs of India Inc. have risen by around 160 basis points (bps) between April 2022 and September 2024. Yet, the rating downgrades have remained contained because of the counterbalancing effect of the healthy growth in profits supported both by well-behaved commodity prices as well as steady (although somewhat uneven) demand conditions across various sectors,” Icra said.

Even as producers of commodities like steel and cement have seen their realizations soften in the past 30 months, their raw material costs, energy costs and freight costs have fallen, allowing entities in these sectors to maintain their profit margins. This is expected to sustain in the medium term on the back of continued investment momentum in the real estate and the infrastructure sectors, the rating agency said.

“Looking ahead, the upcoming festive season, with its potential for increased rural demand and consumer spending, could enhance the credit profile in the second half of FY25. Despite these positive signs, global challenges persist. Weak export demand, the economic slowdown in China, elevated freight costs—particularly due to the Red Sea crisis—and ongoing geopolitical risks continue to pose downside risks,” said Sachin Gupta, executive director and chief rating officer, CareEdge Ratings.

Financial sector

The financial sector (banks and non-banks) too continued the trajectory of strong credit quality, supported by steady credit growth, healthy capitalization and stable asset quality, with India Ratings reporting that over 84% ratings were reaffirmed during the six-month period.

Upgrades were mainly in NBFCs, which benefitted from substantial equity infusion or expansion of franchisee, and consolidation in the industry.

While net interest margins are set to compress 10-20 bps in FY25, low credit costs will support banks’ profitability. Even as the revision in risk weights on some buckets of unsecured lending is driving moderation in lending, credit growth is expected to remain healthy, Crisil said. The ratings agency said lenders’ ability to mobilize cost-effective deposits continues to be a key monitorable.

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Rating agencies pegged credit growth for banks at 14-15% and AUM growth for non-banks at around 17% for FY25.

While saying financial sector downgrades in the first half were largely in smaller NBFCs and fintech companies, CareEdge added that due to the rise in bank lending rates, profitability margins for mid-sized NBFCs are likely to moderate.

As such, rating agencies warned of early signs of stress in microfinance loans and low-ticket personal loans which may lead to higher credit costs.

“There are some emerging pockets of concern, however, like expansion in household debt, growth in unsecured lending, with early signs of rising delinquencies in unsecured retail and microfinance segments. Also, some sectors that have export dependency, namely, chemicals and cut & polished diamonds, continue to face demand and profitability challenges,” said K. Ravichandran, Chief Rating Officer, Icra.

In the last few years, bank asset quality has remained strong. Gross bad loan ratio hit a 12-year-low of 2.8% in FY24. While the gross non-performing asset (NPA) ratio of public sector banks was at 3.7% as on 31 March, private sector banks and foreign banks were at 1.8% and 1.2%, respectively. According to RBI, this gradual decline in bad loans since March 2020 has been on the back of a lower addition of fresh NPAs and increasedwrite-offs.

According to Madan Sabnavis, chief economist, Bank of Baroda, a rating only shows the probability of default, and investments do not take place because a company’s health is better; it only tells us that the company can access cheaper funds depending on the rating.

“While private investments are logically expected to pick up, when and how broad-based it is needs to be seen,” said Sabnavis, adding that when rating agencies publish these data points, they look at it in terms of the number of upgrades and downgrades, whereas ideally, it should also give the size of the exposure. That said, more upgrades compared to downgrades is definitely an indication of the better health of the corporate sector, he said.

Others are more optimistic about the correlation between better credit ratio and fresh investments.

“I think the larger number of upgrades and lower downgrades are positive for future investment and consistent with what is happening domestically. Given the external environment, these upgrades will help attract investment into the country,” said N.R. Bhanumurthy, director, Madras School of Economics.

Bhanumurthy said that large funds which seriously follow ratings can now positively decide to invest in the country. “However, there is downward pressure on the export sector due to the global environment. Both consumption and investment should pick up, contributed by foreign investments.”

Rating agencies expect most sectors to sustain robust balance sheets and healthy operating cash flows through the remainder of FY25. Fast-moving consumer goods (FMCG) companies are expected to perform better than previous expectations supported by recovery in rural demand whereas pharmaceutical formulations are seen benefitting from improved realizations in the US generics market and the sustained volume uptick from new product launches.

Four sectors—specialty chemicals, agrochemicals, textile cotton spinning and diamond polishers—remained constrained due to global headwinds but continue to have strong balance sheets, Crisil said, adding that only sector—automobile dealers—has been affected by relatively high leverage due to a recent significant build-up in passenger vehicle inventory.

83% ratings have a ‘stable’ outlook indicating entities are likely to sustain their credit profiles, higher than 80% in FY24, India Ratings said, adding the share of ratings with ‘negative directional indicators’ has also fallen to 7% from 10% a year ago whereas ratings with a positive bend are stable at around 10%.

(With inputs from Rhik Kundu)