Slowdown around? After five years, CRISIL’s downgrades exceed upgrades

During the glowing figures on Indian economic growth. CRISIL has come out with a surprising discovery that is downgrades are exceeding upgrades for the first time in last five years. So a downturn around the corner or CRISIL playing safe in view of inability of S&P to predict subprime crisis??

CRISIL’s modified credit ratio (MCR, the ratio of upgrades plus reaffirmations to downgrades plus reaffirmations) for the first half of 2007-08 (FH08) has dropped below 1 time — to 0.94 times — for the first time in five years. True to CRISIL’s predictions in its Ratings Round-Up for 2006-07 (FY07), the downgrades during FH08 were driven largely by the increasing risk appetite of corporate managements. Six of the seven downgrades during FH08 were due to acquisitions, or large debt-funded capacity expansions, marking a sharp reversal in the hitherto improving trend of corporate India’s credit quality.

CRISIL believes that changes in managements’ attitude towards risk will continue to drive corporate India’s credit quality. Strong financials can support increasing leverage and vaulting interest costs only to a certain extent; beyond this, aggressive acquisitions or capacity expansions will impact the creditworthiness. Successfully managing growth and integrating acquired entities, and the funding pattern for acquisitions and capacity expansions, are the other major factors that will drive credit quality over the remainder of the financial year. CRISIL expects that corporate India may also face profitability pressures going forward, on account of high input costs. This, coupled with high interest costs on account of a sharp increase in debt, may lead to pressure on companies’ profitability margins, in turn affecting credit quality.

 The declining MCR, and what it indicates: 

CRISIL’s MCR is a strong indicator of systemic credit quality, and therefore of underlying business fundamentals (refer Box 1 for a correlation between CRISIL’s MCR and key economic indicators). In FH08, CRISIL’s MCR for long-term ratings reduced to less than 1 time (to 0.94 times) for the first time in five years, from a level of 1.16 times in FY05. The MCR for FH08 reflects one upgrade and seven downgrades in CRISIL’s long-term ratings (refer Appendix 1 for CRISIL’s upgrades and downgrades of long-term ratings in FH08). The last time downgrades outnumbered upgrades was in FY03, when an MCR of 0.98 was recorded.

The decline in CRISIL’s MCR marks a reversal in corporate India’s trend of improving credit quality. The decline is in line with the view that CRISIL expressed in its Ratings Round-Up FY2006-07, that management attitude towards risk would continue to drive credit quality, with large capacity expansions affecting companies’ credit profiles.

The increasing downgrade rate, and what it means:
CRISIL’s downgrade rate (defined as the ratio of downgrades in long-term ratings to outstanding long-term ratings) increased significantly to 8 per cent in FH08 from 1.7 per cent in FY07 (refer Chart 2).

Rating watch:

CRISIL places a rating on watch when an event has occurred that has potential to impact the rating, but the impact of the event cannot be accurately assessed at the time. As on September 30, 2007, CRISIL had five ratings on watch (refer Appendix 1). Four of these were placed on watch as a result of acquisitions, or the undertaking of projects that were larger than the entities’ current size of operations.