Caught in the debt trap
Report | June 2016 | Kanvic Grey Matter
Almost one-third of Indian companies are caught in the debt trap with profound implications for their growth prospects
The increasingly volatile and uncertain environment and the rise of digital disruption show India’s convergence with important global trends. However, a distinct local factor that is encumbering India Inc.’s growth in the new era is the worryingly high level of corporate indebtedness.
Over recent years, across industries, India Inc. has fallen into a debt trap from which it is struggling to escape. The debt trap is defined as companies that have medium to high leverage and/or low to medium interest coverage. Leverage is calculated as debt as a multiple of a company’s net worth while interest coverage is calculated as operating profit divided by interest outflow.
The Kanvic Performance Navigator has found that the financial health of 18% of companies is critical while a further 12% are in a vulnerable state. Taken together almost one-third of India’s top listed companies are caught in the debt trap. And what is more, the proportion of Indian companies stuck in the debt trap is still rising.
Further, this debt scenario is not limited to listed companies. An analysis of unlisted companies has found that the smallest companies have seen the sharpest rise in leverage in recent years. A quarter of these firms can be defined as ‘weak’, meaning they have an interest coverage ratio of one.
As a result of this situation, the proportion of corporate debt owed by stressed companies (defined as those whose earnings are insufficient to cover their interest obligations) has increased to an eye watering 41% in December 2015.
India Inc.’s high level of indebtedness has both eroded profitability and undermined its capacity to invest. This represents a major obstacle to growth at a time when companies need buffers to withstand shocks from a volatile external environment and surpluses to invest in the new technologies like digital that are re-shaping their industries.
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