Chennai: Corporate debt in emerging market economies including India, which used to average at 49% GDP nearly a decade ago, has now risen to 55% of GDP, said a latest RBI report.
India stands at the seventh place, when measuring its government debt to GDP ratio far behind countries like China, Indonesia and Malaysia. The report also sheds light on how the system could be setting itself up for more cases of wilful defaulters like the now defunct Kingfisher Airlines. In a study of firms with more than $1 billion assets over 19 years, it was found that bigger corporates tend to be more leveraged post a crisis, compared to smaller firms.
Why it matters? In December, the Reserve Bank of India (RBI), in its fifth bi-monthly policy statement held rates for the first time in 2016 given the excess liquidity entering the system post-demonetisation.
From some quarters the low-interest rate regime was hailed as the right time for pushing more loans to consumers, but a latest RBI report cautions against such a move. Titled, 'Corporate Leverage in EMEs: Has the Global Financial Crisis Changed the Determinants?' the report draws parallels to the 2008 financial crisis.
"The post crisis period was characterised by abundant global liquidity and search for yield, which possibly resulted in lenient credit-score evaluations and leverage built-up. It is also possible that these firms with low profit took advantage of their possible future upturn and borrowed cheaply from debt markets," said the report.
Given the RBI's successive interest rates and current neutral stance, it is possible that we are on the cusp of a change in the policy rate cycle. And its at this juncture, the reports warns that lenders need to exercise more prudence. "This apparently innocuous outcomes of quantitative easing, in absence of a concomitant increase in investment levels, disguises a possibility of financial distress as it points towards possible non-productive use of these borrowed funds," said the report, outlining how loans given in haste could turn toxic in time.
Moreover, the result implies that the prolonged low interest rate regime as a pull factor behind the build-up of corporate leverage which suggests the possibility that leveraged assets may turn toxic with the change in policy rate cycle," added the report.
The RBI report studied the economies of 10 emerging countries, including Brazil, China, India, Russia and South Africa. Post-demonetisation, analysts feared higher loan defaults from MSMEs more than large corporates. But the report's findings show that its not MSMEs but large corporates, who are more likely to default after a crisis.
"The coefficient of profitability is significant only for large firms in the post-crisis period; larger firms, which in normal circumstances have access to greater retained earnings, find themselves in an environment characterised by less retained earnings but low cost of external funding and availability of abundant liquidity. Our results suggest that these pull and push factors may have together resulted in the higher leverage of large corporates," said the report.
Another counterpoint to mainstream views the report makes is that it lends credence to corporates who tend to shift blame and say, "It's not us. It's the economy." "Don't blame only the firms for defaults, the economy paper counters the mainstream view that firm level factors are of pivotal importance as determinants of corporate leverage and presents evidence that the changed macroeconomic scenario led to the sharp rise in corporate leverage in EMEs in the post-crisis period," said the report.