Rupee fall to not hit oil firms' ratings now, says Fitch

Fitch Ratings has said the rupee depreciation has varying levels of implications for energy and utilities companies in India, but their ratings are not immediately affected. Among the Indian energy sector issuers currently rated by Fitch, the risks to stand-alone financial profiles are the highest for state-controlled oil marketing companies (OMCs).

The Indian rupee has depreciated by over 25 per cent versus the dollar since April 1. Fitch expects limited negative credit implications for most of the rated issuers due to natural or financial hedges or, in the case of utilities, tariff mechanisms that allow for exchange rate fluctuations.

The rated oil and gas companies have a significant proportion of foreign currency-denominated debt.

However, they benefit from the hedge in their operations. Utility companies have a much lower proportion of foreign currency debt and at the same time have the ability to pass on foreign exchange fluctuations as part of their tariff-setting mechanisms. This provides them with greater protection against the depreciation of the rupee.

OMCs such as Indian Oil Corporation Ltd (BBB- / stable) and Bharat Petroleum Corporation Ltd (BBB-/ stable) had over 50 per cent of their total debt in foreign currencies at the end of FY13.

However, the computation of the subsidy amount to cover under-recoveries arising from selling certain fuels below market prices is based on US dollar terms. Because their refining margins are also linked to regional refining margins denominated in the dollar, the profitability of the refining operations will benefit from the rupee depreciation.

Regular increase in diesel prices has reduced the under-recoveries and therefore, the subsidy requirement. However, the rupee depreciation will reverse this trend. While further price increase for diesel is being considered to reduce the subsidy requirement, the quantum of increase remains challenged by pressures on consumer inflation and political dynamics in India.

In recent years, both IOC and BPCL have been almost fully compensated for their under-recoveries by direct subsidies from the government as well as those from state-controlled upstream companies. However, delays in receipt of subsidies at a time when the rupee is on a freefall could lead to higher working capital requirements, debt and interest costs for state-owned downstream operators.

This can be further exacerbated if the downstream entities are to bear a share of the under-recoveries. However, according to Fitch, these entities will have sufficient access to funding sources, primarily the domestic banking system to manage their liquidity requirements given their strong state linkages. The ratings of IOC and BPCL are equalised with that of the sovereign (BBB-/Stable).

Given the pressures on federal finances, it is possible that the state-linked upstream companies, whose cash generation is unlikely to be negatively affected by the rupee depreciation, may be asked to increase their contribution towards downstream fuel subsidies.

Within the oil and gas portfolio, GAIL India (BBB- / stable) had the lowest proportion - of around 30 per cent - of foreign currency debt at the end of FY13, which it has partially hedged with interest rate swaps and forward currency swaps. A majority portion of the hedging was done in the past five months. Fitch does not expect GAIL’s operating cash flows to be impacted significantly due to the cost pass-through pricing mechanism. GAIL, too, has sufficient rating headroom, with its standalone rating being constrained by the sovereign.

Reliance Industries (BBB- / stable, BBB / positive) had a 92 per cent of its debt in foreign currency at the end of FY13. However, RIL has a natural hedge, with both its raw materials as well as final products priced in the dollar. At the end of FY13, RIL had also hedged its currency and interest rate exposures through interest rate swaps (Rs 32,400 crore), currency swaps (Rs 3,300 crore), options (Rs 2,300 crore) and forward contracts (Rs 89,400 crore). The hedging covers the company's debt, imports and its exports. In FY14, RIL has to repay $2 billion of long-term foreign currency debt. It recently completed a $1.75 billion bond issue, of which $1.2 billion will be used to refinance this debt.

Of the electricity utilities, NTPC (BBB- / stable) and Power Grid Corporation of India (BBB- / stable) had around 30 per cent of their debt in foreign currency, while NHPC Ltd's (BBB- / stable) share was 11 per cent at the end of FY13. None of these entities has hedged their foreign currency exposures. The tariff mechanism allows for foreign exchange variations, which will let them pass on the foreign currency impact to the customers limiting the overall financial impact from the depreciation of the rupee. All three ratings have sufficient headroom, with NTPC's and Power Grid Corporation’s standalone ratings being constrained by that of the sovereign, while NHPC's standalone is at the same level as the sovereign at 'BBB-'.

As the ratings of the state-linked entities are either equalised, at-the same level, or constrained by that of the state, any negative rating action on India will have similar implications on their ratings. RIL's foreign currency issuer default rating of BBB- / stable, which is currently constrained by the country ceiling of India, can also be negatively affected if the country ceiling is downgraded.