Crisil flashes amber signal

NEW DELHI: Just a month after global rating agency Fitch warned that unabated loan growth may lead to a systemic crisis in the banking industry comes another caution alert, this time from domestic rating firm Crisil.

Pressure on credit quality, Crisil’s rating division warns, is increasing and will only escalate in the coming 18 months. Credit quality is a measure of creditworthiness, reflecting a bond issuer’s capacity to repay borrowings. The manufacturing sector, it says, would be the most vulnerable.

Crisil is basing its caution on the steady decline of its modified credit ratio (MCR) — the ratio of upgrades plus affirmations to downgrades plus affirmations — since the end of 2004-05.

The MCR has dropped to one in April-September 2006, down from 1.03 at the end of the 2005-06 fiscal year and from 1.05 in April-September  2005. The MCR at the end of 2004-05 had been 1.15 and was the peak of a three-year rise.

The Fitch caution appeared to be based largely on retail credit growth, and most bankers and economists were quick to dismiss its doomsday prophesies, pointing out that overall credit quality was very good.

However, the fact that Crisil’s MCR relates to corporate lending could serve as a wake-up call. Indeed, Standard Chartered Bank’s latest Credit Research study notes that the credit growth has been fuelled by an increase in industrial activity, which has, in turn, pushed up corporate investment demand.

Crisil identifies rising interest rates as one of the reasons for the decline in credit quality and notes that pressure on this front is not likely to ease in the near term.

It’s the manufacturing sector, which is on a roll these days, that needs to be watched closely, according to Crisil, with the MCR having declined to 0.98 (from 1.07 in 2005-06). While the MCR of the infrastructure sector remained flat at 1, that of the financial sector moved up to 1.04 from one in 2005-06.

What makes the manufacturing sector particularly vulnerable is the increase in input prices, higher capital expenditure, a large number of debt-funded acquisition and continuing high interest rates. The last could not just push up the cost of capital for companies but also affect demand for consumer durables. The manufacturing sector will continue to face pressure, Crisil notes, though the impact could be muted because of the strong credit profiles of India Inc.

The outlook for the infrastructure sector, though subject to the vagaries of both oil prices and government policy, is largely expected to remain stable, given the expectations of policy reforms. Crisil appears least worried about the financial sector, though increasing interest rates could pose new challenges, with higher interest spreads on the lending business balanced by higher market and credit risk. However, the backing of the government or strong foreign parents will lend stability to the overall credit risk profiles of companies in this sector, Crisil notes.

But should the banking sector worry? Not really, going by Standard Chartered’s Credit Research. For one, it says, the asset quality of banks has improved significantly, given the changes in the institutional framework for dealing with bad loans and improvement in the credit environment. Besides, India Inc is now supplementing borrowing from banks with tapping capital markets at home and abroad to access debt and equity funds. In any case, Reserve Bank has tightened prudential norms and allowed banks to access hybrid capital to help them meet their longer term risk objectives.