India's Credit Squeeze

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India Desk

At the start of 2020, few in India thought they would be looking back longingly to the quarter-ended September 2019, when India’s quarterly GDP growth dropped to 4.5% (a six-year low) and experts bemoaned weak manufacturing, falling consumer demand and private investment, and rising unemployment. Then again, these are distinctly unusual times.

The Indian government mandated a nationwide lockdown from 25 March 2020 to 31 May 2020, and although restrictions have eased since that time, mobility remains limited. Macro-economic data published during the lockdown reported GDP growth for the year-ended 31 March 2020 (fiscal 2020) at a decade-low of 4.2%, with bank credit growth said to have decelerated to over a five-decade low of 6.14%. Although the first Covid-19 case in India is suspected to have been diagnosed at end of January 2020, the seriousness of the situation became evident by mid-March 2020. The poor economic performance for fiscal 2020 is said to only marginally reflect the Covid impact and is mostly attributed to the lower demand and risk aversion amongst banks.

A long time coming

Some of the underlying causes of the banks’ current stance on credit date back many years. While May 2016 marked the adoption of the much-anticipated Indian Bankruptcy Code legislation (covered in our 2018 insight here), India’s recent economic pressures begin soon after the policy-shock of November 2016 when the government ‘demonetised’ or voided more than 99% of the country’s currency overnight. This significantly adversely impacted the ‘informal’ sector where cash transactions dominate and which is estimated to dominate economic activity and domestic demand.

Soon after, in July 2017, the government followed with the implementation of a national Goods and Service Tax (GST) system which replaced a myriad of complex state taxes. While this was an eagerly awaited reform, and companies benefited from operational efficiencies bought about by doing away with inter-state taxes, the numerous new GST tax brackets, a significant increase in filings, and considerable inventory destocking, resulted in the manufacturing sector reporting muted results in the ensuing quarters.

The 2018 bankruptcy of systemically important infrastructure financier, IL&FS, led to significant refinancing pressures in capital-intensive infrastructure projects with banking and investor sentiment towards non-bank financial companies (NBFCs) taking a sharply negative turn. Credit flow from NBFCs (said to account for circa 20% of total credit in India) to the commercial sector is reported to have declined 19.4% for fiscal 2019. The worsening impact on credit portfolios was evidently due to the economic slowdown, and by September 2019, estimates suggested that a staggering 9.6% of total Indian banking assets were ‘bad loans’, with government-owned banks (Public Sector Undertakings or PSUs) accounting for little over 60% of total assets but responsible for a relatively far larger share of these bad debts.

Indian commodity traders are also likely to have been impacted by the decision by India’s central bank, the Reserve Bank of India (RBI), to change the provisioning norms for undrawn working capital lines implemented from 1 April 2019 onwards. This has made banks more wary and price sensitive of servicing this sector.

The impact of Covid-19

While data for 1Q fiscal 2021 (three-months ending 30 June 2020) is expected to be negative due to the almost complete halt in activity, the central bank governor also suggested that GDP would be negative for fiscal 2021. A McKinsey & Co., study from April 2020 was reported to have estimated that India’s economy could contract by around 20% in 1Q fiscal 2021, with full year contraction ranging 2% - 3%. Although macro-economic data will trickle in, and studies will be fine-tuned as the pandemic evolves, the impact of the slowing economy on private companies’ fiscal 2020 financial statements and those for fiscal 2021 will only be available with a considerable lag. 

However, while bankers suggest a slowing economy had significantly reduced demand for credit, anecdotally, businesses complain of a hitherto unseen level of risk aversion amongst bankers. Certain industries have done themselves no favours on this front, with one of the reasons given by our sources being a scam (the extent of which was discovered in May 2018), involving a diamond merchant, in connivance with bank employees, allegedly defrauding a PSU bank to the tune of USD 12.1bn across 1,213 “Letters of Understanding” issued to foreign banks between 2011 to 2017 (the RBI has clamped-down on the particular structure since). The recent high-profile reports of default by global commodity traders such as Hin Leong Trading Pte Ltd (to which Indian lender ICICI Bank is said to have had an exposure of circa USD 100m) have added to a sense of nervousness. Some sources across industries appear to have a perception (behind closed doors) that there is now a tendency for investors/regulators/public opinion to attribute failure to fraud despite the loan going bad due to a ‘genuine’ miscalculation of risk/exuberant projections. Market feedback suggests that this risk aversion has resulted in significant delays for sanctioning new bank lines, with onerous paperwork and onboarding requirements. Some traders complain that credit offered comes with increasingly high transaction/bank charges, eating into their already-thin trading margins. However, with government efforts to reduce interest rates and increase liquidity, the net cost impact remains to be ascertained.

Real world impacts

To that end, Infospectrum’s real-time feedback loop for reports has provided some useful insights regarding available liquidity and working capital pressures for India-based commodity traders. The credit squeeze has been particularly acute for Small and Mid (SME) sized traders that have little by way of tangible assets to offer as collateral.

While market sources report that dealings are being restricted to long-standing counterparties, the tightening of credit from more formal banking channels has seen a focus on extending receivable-payable cycles. There have been reports of larger companies successfully negotiating more favourable payment terms from suppliers (feedback sourced suggests these have ranged from 45 days extended to 60 days, or from 60 days to 70 days). A source at a commodity trader of scale suggested that the Covid pandemic had led his company to explore options to avoid paying freight in advance (essentially funding the operators who were perceived to have little skin in the game). On the other hand, there have also been reports wherein the ship owners and operators have expressed frustration that cargo receivers were using the lockdown as an excuse to get out of procurement commitments that were out-of-money. To that end, commodity traders and operators are facing a two-fold setback – extended receivable days from demanding larger customers, and suppliers (often global), taking a far stricter approach with reduced tolerance for payment delays as the market gets more risk averse.

Optimism and Opportunity

As lockdown eases, and businesses limp back to normality, sentiment is turning cautiously optimistic. The Indian government and the central bank have announced a slew of relief measures to address the financial and operational constraints resulting from the pandemic. For instance, debt repayment moratoriums have been extended till 31 August by the central bank, and the government has suspended the Indian Bankruptcy Code, potentially for a year. This is particularly relevant as it prevents lenders being forced to refer any loan overdue beyond 90 days to the corporate resolution process, since the Code currently denies the option to restructure loans. More recently, this has been followed by the RBI giving banks the flexibility of restructuring non-performing loans.

Although still at the early stages of adoption, Indian traders have reported using new sources of financing and factoring services from foreign fin-tech companies. These alternative sources of funding could establish a possibly lasting position in the financing mix, potentially increasing the USD 250 bn share held by non-banking and other institutions of the annual circa USD 9 trillion global trade finance market (International Chamber of Commerce’s estimates).

So what now?

The very significant disruption caused by Covid-19 has certainly added further layers of stress to an already challenging Indian financing market. While new entrants will take advantage of pull-backs by established banks, the need for extensive due diligence on the risks at hand has never been greater. Our India desk has significant experience in this area, keeping a close eye on new structures, rules and regulations in one of the most dynamic sectors we cover. Get in touch if you want to discuss how we can assist.

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Published on 10 Aug 2020

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