• Abhijit Maheswari

Signal from the credit market and the case of deleveraging

Updated: Feb 22

Have Indian companies successfully deleveraged in 2020 ? I think they have. And I will also argue why this is good for the economy. After years of accumulated debt and severely constraining the capacity of banks because of bad loans, we are perhaps entering a period of balance sheet refactoring by companies. They are raising capital in a hurry, not by bank loans but directly from retail investors via IPO or rights issue.


Timing the market ?


Booming stock market with high valuation could be seen as a 'perfect time' to raise capital for the companies, either by listing their company shares in a stock exchange or issuing new shares to existing public investors. But the idea of a 'perfect time' is debatable.


Though some will argue second half of 2021 was an opportune time for building capital reserve based on external environment rather than actual need. These high valuation regime allows companies to raise more money with the same number of share issues than they could do during the low-valuation times (bearish market).


For the financial market, 2020 was a year like no other.


A rational approach in this super charged market would have been to raise money directly from the market. And that is what Indian companies did. We broke the 2019 record by raising INR 1.7 trillion, an 116% year-on-year jump from 2019.


This should not be a bad outcome either. Taking money directly by selling shares making equity investor partner in your business also will deleverage many companies. Since valuation became very attractive, it was a good time do so.


However the overall credit or outstanding loans by the industry has increased by just 0.48%.


The importance of credit in economy


Let's remind ourselves that expansion in credit is also a sign of growth in GDP and negative credit growth signals a contraction.


Indian economy did contract in 2020-21. Different figures are floating based on whom you read. Broadly, most expects that economy will contract in the range of 7% to 10% for the full year.


Ray Dalio, founder and chairman of the Bridgewater associates, an hedge fund with over USD 120 billion dollar under management, has demystified the role of debt on the economy cycle with a self narrated youtube video,"How the Economic Machine Works". Whatever you background might be, I strongly encourage everyone to build an understanding of this part of the economics.


With marginal increase in overall credit with major sector showing negative growth, India's statistics is playing by the economics rule book. Our credit didn't grow and our economy contracted. The credit flow in the economy tells a lot about the health of economy at any point for time. It can certainly tell you about general business sentiments and whether businesses see a reason to increase their capacity by taking credit and raising money.


Credit growth by Industry for the year 2020




What happened in 2020-21 ?


The BSE S&P sensex has touched an all time high of 52,000. Does it mean we are the end of bull run or does it mean we are just getting started ?


Despite a loose monetary policy followed by RBI since April 2020 with most stimulus on the account of corona pandemic coming in the form of non-fiscal, companies in India haven't gone taking on new credit.


Not all things are equal. Flow of credit to industry was non-linear. Reading of industry-wide credit statistic - like 0.48% growth in overall credit growth - could be misleading as some industries play a larger multiplier role than others.


Yes, some companies bore the grunt of lockdown measures more than others. These companies were hit by the restriction in the movement and they would have difficulty servicing their existing loan. They will be defaults and bank will cut down on credit. There are millions of small to medium enterprises in India, and most of them don't have access to capital the way top companies would have.



Monthly credit outstanding by Industry




What is the credit data from different industries telling us ?

  1. Engineering businesses saw a double digit decline of more than -12% in credit/loans. The drop in engineering was more pronounced than construction and infrastructure. This certainly raises some flags on the economy and growth prospect for 2021-22.

  2. Vehicle equipment, parts and transport sector saw a increase of 5% in credit. One possible explanation for these businesses doing well is - vehicles, cars, bikes, scooter, trucks didn't move during the lock-down. Because of the non-use it would have required more maintenance and replacement of parts. Incidentally, I saw this first hand during my walk in the lockdown, that tyres of dormant cars showing the tear from inactivity. This also reflects in the 5% y-o-y growth of credit in rubber and plastic industry.

  3. Food processing saw the highest growth in credit based on y-o-y comparison which is not surprising as comfort food and packaged consumption increased in 2020.

  4. Gems and Jewellery saw a sharp uptick in credit during the festive season.

  5. Infrastructure sector is by far the largest user of credit. If we want to manage the NPA problems of the bank, then government should be advised to make sure projects don't stall, rules are not changed mid-way, income as foreseen in the project report should be allowed to fructify, alternative capitals should be explored like bond or rail plus property used in Hong Kong. Infrastructure because of its weight in credit market can have both negative or positive multiplier effect. What affect do we want ? NPA and resulting credit crisis we just went through is an example of negative multiplier. The credit crunch chocked the flow of money is viable projects and turned some viable projects into NPA. If the handing of infrastructure projects don't improve for better, don't be surprised if we see another NPA led banking crisis in 3-5 years.


Conclusion


Indian companies did well to raise public money in 2020. Many of the companies were able to build their cash reserve for the unforeseen consequences of the pandemic. Some of them were able to pare down their debt level by raising money through stake sale. This sets them well for a period of fiscal expansion which government of India has revealed in the 2021-22 budget. But they also need to return to credit market. All said and done, public equity is expensive and expansion in credit will also signal the growth in Indian GDP.