Healthy companies

The initial bunch of quarterly corporate results has been very upbeat, but it's early days yet and judgement should be withheld on whether the fears about a deceleration in profit growth were unfounded.

With oil prices still high, many raw material prices climbing and interest rates a tad higher, margins are certainly under pressure. The macro numbers have also indicated a slowdown in the fourth quarter, with the Index of Industrial Production showing slower growth and the infrastructure index slipping into negative territory.

Going forward, if the government is forced to raise fuel prices, auto demand may well slow down. And on the export front, slower global growth may hit demand.

In sum, there have been plenty of reasons to expect a slowdown in profit growth. Which is why the study by the rating agency Crisil, indicating that India Inc's credit fundamentals have never been better, is very welcome.

Crisil arrived at its conclusion on the basis of a study of trends in rating companies. The research shows that the modified credit ratio (MCR), or the ratio of upgrades plus reaffirmations to downgrades plus reaffirmations, is at an all-time high, passing the previous high recorded in FY95.

The downgrade rate, defined as the ratio of total downgrades to outstanding ratings, is at a 10-year low. Crisil also points out that growth has been broad-based across sectors.

Much of this is well-known from the stellar corporate results notched up in the past year, with strong growth in both revenue and profits for most companies.

It's also axiomatic that good corporate performance will be matched by better credit quality, leading to more upgrades and fewer downgrades.

More interesting, therefore, are some of the other points made in the study. For instance, while Crisil agrees that higher oil prices and slower global growth could lead to lower earnings growth, the relevant point is that India Inc. is now far better equipped to weather a slowdown than it was in the late nineties.

Companies have used the upturn in the business cycle to strengthen their balance sheets, reduce high-cost debt, prune unproductive expenditure, shed flab and tighten up their working capital.

The upshot has been the creation of leaner, stronger companies. The Crisil study points out that these factors will enable firms to withstand margin pressures and slower growth without affecting credit quality.

Another important point relates to the financial sector. Like their corporate clients, banks too have used their period of super-normal profits to reduce their non-performing assets.

The Crisil study points out that banks' ability to pass on increased costs to borrowers will protect their earnings. Further, asset quality is unlikely to deteriorate.

And finally, the research paper confirms anecdotal evidence about higher capital expenditure by companies. It says that fixed investment is indeed taking place, driven by higher operating capacity, growing business confidence and negative real interest rates.

Those real interest rates may have turned positive, but they continue to be low. Most importantly, Crisil believes that the capital expenditure will not put undue strain on companies' capital structures.

In short, the key takeaway from the study is that while there may indeed be a slowdown in corporate growth, this time the downside is very limited.