India's pro-cyclical industries to benefit from improved credit conditions through 2016
By Rahul Ghosh, a Vice President and Senior Research Analyst for Moody's Investors Service.
The latest economic data in India suggests that a cyclical pick-up in economic activity is likely, as seen by the country’s expanding purchasing managers’ indices for the manufacturing and services sectors. Leading investment indicators such as capital goods production and commercial vehicle sales point to a gradual bottoming out in India’s capex cycle.
A number of stubborn macroeconomic challenges have also eased significantly. Consumer price inflation has fallen to the mid-single digits, while the country’s current account balance is running at a historically mild deficit of 1.1% of GDP.
The reduction in both the country's headline inflation rate and current account deficit provides a more stable backdrop for India corporates in terms of EBITDA margins, market borrowing costs and the exchange rate.
Lower input Prices Have Improved EBITDA Margins
Note: EBITDA margin taken for listed companies on the National Stock Exchange CNX Nifty Index
Sources: Moody's Investors Service, Bloomberg
Credit conditions should therefore improve for non-financial corporates and infrastructure debt issuers in pro-cyclical industries in India over the next 12-18 months.
The improvement will be due to an upturn in economic growth, the banks' pass-through of interest rate cuts, weakness in international commodity prices and the government's pro-growth policy agenda.
Industries that are most directly correlated to India's domestic economic cycle, such as industrials, transport infrastructure, metals and automotives should see their credit conditions improve the most through 2016.
By contrast, issuers in the upstream oil and gas, and chemicals sectors will see their earnings and cashflows pressured by weak oil prices globally.
Credit Conditions to Improve in Pro-Cyclical Industries
Note: Green shading indicates improvement; blue shading indicates stability; red shading indicates deterioration.
Source: Moody’s Investors Service
However, structural challenges persist and recent policy changes will take effect only slowly. The ability to push through key structural reform will therefore be key to maintaining economic growth rates in India. For example, the government’s ability to pass the Land Acquisition Bill and a unified goods and services tax will be crucial in maintaining positive policy momentum.
Several industries will continue to wrestle with structural challenges, even as cyclical conditions stabilize or improve. Such challenges include oversupply in the real estate market and weak finances among state electricity boards.
Recent policies — including diesel price deregulation, and the lifting of the iron ore mining ban — will benefit refining, metals, steel and power companies.
In March this year, the government passed the Coal Mines Special Provisions Bill and the Mines & Minerals Development and Regulation Bill, with the former effectively ending four decades of state monopoly on coal mining. India has suffered from chronic coal shortages, despite having the fifth-largest proven coal reserves globally at 60.6 billion tons at end-2013.
Other sectors have yet to see a specific boost from government policy, but will likely benefit from the government’s pro-growth agenda.
Monetary easing efforts will reduce borrowing costs for companies and stimulate consumer demand for domestic-focused industries. However, the banks are unlikely to pass on fully any policy rate cuts to borrowers. The banks will also likely maintain a more conservative approach to fresh lending in sectors where asset quality remains a risk.
As for the weak commodity prices globally, the historically low prices will lower operating costs for sectors such as automotives, manufacturing, infrastructure and power, but will weigh on upstream oil and gas, and chemical companies.
The drop in oil prices, for instance, and the new supplies of liquefied natural gas (LNG) from Australia and the US, will push down LNG prices over the next few years. Such a situation should help India, which is the fourth largest importer of LNG, and which remains significantly gas starved.
As for lower crude prices in particular, this development has provided the government with an opportunity to enact energy subsidy reform, which will benefit India’s downstream oil marketing companies.
Debt levels will in general stabilize for Indian corporates, as their earnings rebound and margins recover. On a weighted average basis, debt-to EBITDA should stabilize at 2.8x in 2015 because an upswing in earnings — on the back of a recovery in economic activity — and improving margins should help shore up key credit metrics.