The reasons for quick recovery by the corporate sector in India can be attributed to the fact that debt financing by Indian corporates is not very high as compared to global levels
Early days of the COVID-19 pandemic witnessed severe lockdowns in the country as around the world, disrupting businesses and raising alarm about likely increase in insolvencies.
In this context, the credit insurance company Euler Hermes, in July 2020, forecasted a +35 percent cumulated increase in its Global Insolvency Index over a two-year period. Similarly, the IMF, in July 2020, projected that the insolvency of SMEs may triple from 4 percent to 12 percent and insolvency in the service sector may increase by 20 percent. These forecasts came in the backdrop of big business houses of the aviation, hospitality, fitness centres and energy sectors such as Virgin Atlantic, Gold’s Gym, Avianca, CMX Cinemas and Apex Parks going into bankruptcy during the pandemic period. There are a number of studies by the World Bank and IMF indicating increasing levels of corporate stress and likely increase in insolvencies.
Parallels between the present crisis and the 2008 global financial crisis (GFC) have been drawn in terms of risk of rise in insolvencies, given that the latter had resulted in a spike in corporate bankruptcies in many developed countries like Japan (4.9 percent), UK (5.88 percent), Germany (11 percent) and US (40 percent). However, there are some differences between the situations in present times as compared to GFC.
Situation before the pandemic
Globally, the corporate sector was in stress even before the pandemic. The global non-financial sector corporate debt levels, as percentage of global GDP, going into the present crisis, was 91 percent in the beginning of 2020, as compared to 73 percent in 2007 in the run up to the GFC. Private debt increased by 176 percent in developed markets and 973 percent in emerging markets between the period 2005-07 and 2017-19. Thus, the situation of corporate debt was precarious given that the sector was already on high leverage. Unlike the crisis of the past, the pandemic directly impacted the balance sheets of corporates with the potential to spill over to balance sheets of banks and financial institutions (See Table below).
|Particulars||2008 GFC||2020 COVID-19 pandemic|
|Initial shock to the balance sheet of||Households; Banks||Businesses; “Non-bank” high yield lenders (collateralised loan obligations, mutual funds)|
|Sources of capital||Limited private capital; Official sector||More transparent and better capitalised banks; Private capital|
|Non-financial sector Corporate leverage (% of Global GDP)||73%||91%|
|Household leverage (% of Global GDP)||57%||60%|
|Public sector debt(% of Global GDP)||58%||88%|
Source: Report of G30, “Reviving and Restructuring the Corporate Sector post Covid”.
In the Indian context, on the macro-economic front, in the run up to the pandemic, bank credit to the industrial sector was slowing down. Outstanding credit of SCBs to the corporate sector was about 45 percent of total outstanding as in March 2020. Gross non-performing assets (GNPA) ratio was projected to increase from 7.5 percent in September 2020 to 11.5 percent for FY 2020-21. Credit growth had decelerated to 5.4 percent in 2019-20.The health of the corporate sector was showing signs of stress in general.
During the pandemic
The domino effect of the crisis spreading to multiple sectors and economies resulted in global output contraction at -3.3 percent in 2020.The pandemic also led to a decrease in global trade volume which contracted -8.5 percent in 2020 and FDI flows which were projected by UNCTAD, to fall by 40 percent in 2020, falling well below the low reached during the GFC. India’s real GDP growth rate contracted by 7.3 percent in FY 2020-21, the first contraction since 1980-81, with activity in the manufacturing and service sector decelerating sharply during this period. Credit growth decelerated further to 2.5 percent in 2020-21.
While 2020 saw contraction in all output indicators, recent projections by the IMF have ignited hopes of economic recovery as the global economy is projected to grow by 6 percent in 2021 and 4.9 percent in 2022. Backed by generous government fiscal support and regulatory forbearance policies, businesses in India have also shown resilience in the face of the COVID-19 crisis. According to the RBI, 77.5 percent of MSMEs were granted loan moratorium by lenders, which was 69.29 percent of the total exposure of the financial sector to them. As regards the corporate sector, 31.31 percent of companies availed the facility, which was 34.28 percent of the sector’s total loans. GNPA ratio actually stood at 7.5 percent in 2020-21 as against the projected 11.5 percent.
Corporates are already showing signs of recovery after the government eased restrictions and lifted lockdowns, since Q3 FY2020-21. There has been across-the-board improvement in net sales, PAT, operating profits and PBDIT from September 2020 onwards for non-financial NSE 50 and NSE 500 companies. RBI has reported that after deterioration in H1:2020-21, private corporate activity revived during H2:2020-21 after gradual opening of the economy. Nominal sales of 724 listed private companies increased by 6.8 percent and 31.7 percent in Q3 and Q4 of FY 2020-21. The IT sector also experienced 6.5 percent growth in sales during Q4.
Mitigating factors in India
Several factors have mitigated translation of financial stress into insolvency of corporates in India. Examining the degree and scale of exposure of the banking sector to the corporate sector in India, on the demand side of credit it is seen that over the last two decades, Indian firms have been using equity financing (retained earnings and fresh issue of equity) more than debt financing, with credit from banks being the largest source of external finance. Thus, to a certain extent the reasons for quick recovery by the corporate sector in India can be attributed to the fact that debt financing by Indian corporates is not very high as compared to global levels.
On the supply side of credit to corporates, the growth of non-food credit by SCBs slumped to half its rate in 2019-20 vis-à-vis the previous year and further declined to 4.9 percent in 2020-21, reflecting weak demand and risk aversion among banks. The unabated weakening of economic activity, coupled with deleveraging of corporate balance sheets and risk aversion by banks due to asset quality concerns, were accentuated towards the close of 2019-20 by the pandemic, leading to a reduction in the incremental credit-deposit ratio from 77.7 in 2018-19 to 76.4 in 2019-20 and further to 72.7 in 2020-21. The credit-to-GDP gap has been wide, ranging from 50-53 percent over the period 2011-12 to 2019-20. It widened during 2020-21 to 56.4 percent, reflecting the slack in credit demand. Data on sectoral deployment of bank credit for March 2020 points to a broad-based slowdown. Credit growth to industry fell sharply from 6.9 percent in 2018-19 to 0.7 percent in 2019-20 and further to 0.4 percent in 2020-21.
In the Indian context, based on the mitigating factors, identified above, as compared to advanced countries, corporate level stress is not expected to be too high. However, the threat of corporate stress turning into insolvencies still exists, especially for those sectors that were most affected by the pandemic. There is a need to prepare for early interventions to address any corporate financial stress. It would be extremely crucial to triage corporates into those that need aid and those who do not for efficient allocation of resources to those who need it the most.
Sushanta Das and Medha Shekar are officers in the Insolvency and Bankruptcy Board of India. Views expressed are personal.