Downgrades of rated instruments by credit rating agency Icra have outnumbered upgrades for the first time in many years. This is a clear indication that rising costs are straining company cash flows and leading to a reassessment of credit ratings of financial instruments issued by corporates.
"A lot depends on the impact of the cyclical cost push and to what extent this price shock can be absorbed by companies," said P K Choudhury, the vice-chairman and group CEO of Icra.
Talking to Business Standard, the CEO said there was rising apprehension regarding the mounting cost pressure across all sectors.
"With the increase in purchasing power of consumers, there is an increase in demand. Thus despite inflationary pressure, sales are surging. But beyond a point, marginal players would be affected," he added.
Amidst high inflationary pressure, the financial health of industrial units and the rating of their financial instruments will depend on their capacity to absorb incremental cost, he indicated.
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The efficiency of industrial units should not be judged by statistical parameters such as increase in revenues and net sales alone. Proper weightage has to be assigned to other parameters as well, like quality of management and efficiency of the system, all of immense importance for bailing out a unit in times of a cyclical shock.
Credit rating sector sources say only 30 per cent weightage is given to statistical parameters and increased weightage is being given to other qualitative parameters.
With the opening up of markets, there is mounting pressure on domestic units from foreign competitors, which enjoy advantages in terms of cost efficiency and other factors, he added.
On the positive side, efficiency of the Indian industry has improved and Indian companies are now fairly successful in achieving global quality standards.
"Despite inadequate supply of skilled manpower and high cost of working space, the service sector still has a potential to achieve higher growth by the virtue of high quality, which many of the other countries have failed to achieve, but there is no space for complacency," he added.
The recent rating transition trend that has surfaced shows that the number of rating downgrades exceeded the number of upgrades in 2007, which is a departure from previous years.
According to the latest Icra report, this trend can be understood from the inv-CR (inverse credit ratio), which has increased consistently over the last three years from 2005.
In 2006, inv-CR increased to 0.83 from 0.33 in 2005 and in 2007, it further rose to 1.13.
For corporate entities, inv-CR declined to 1.75 in the last year from 1.25 in the previous year.
However for the financial sector, the ratio improved to 0.5 from 1 over the same period.
"This is quite a contrast that when the economy is doing so well the number of downgrades in ratings is higher than the upgrades," Choudhury remarked.
The downgrades of ratings are spread over a large spectrum of the industry including commodities, financial services, power and pharmaceuticals.
About 45 per cent of the downgrades are due to weakening of capital structure following a large debt-funded expansion and reversal of the relevant commodity cycle, whereas pressure on earnings on account of external or internal factors resulted for the rest of downgrades.