Lower cost of capital is a shot in the arm for Indian companies

An analysis of 1,311 non-bank, non-finance companies by Care Ratings Ltd showed that their interest coverage ratio rose from two times in Q4FY20 to 7.1 times in Q4FY21.

Interest coverage ratio is defined as earnings before interest and tax (Ebit) as a multiple of interest cost.

For the full year FY21, this metric improved from 3.38 times to 4.95 times for 1,734 non-bank, non-finance companies. Furthermore, interest expenses came down by 6.2% in FY21, showed the analysis.

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According to Care Ratings, Indian companies also used the liquidity sloshing around to raise equity capital and reduce debt. Whatever the causes, it is remarkable that in a year when profits were hit badly, interest coverage ratio improved.

A recent study showed that not only the cost of debt, but even the cost of equity has reduced for Indian firms.

“Our analysis shows that the interest cost for Indian corporates has been the lowest in the past six years. The cost of equity has also dropped, as expectations have been toned down over the past several years, as companies get a realistic handle on their growth trajectory ,” said Tirthankar Patnaik, chief economist, National Stock Exchange of India Ltd (NSE India).

The latest cost of capital survey conducted by consultancy EY and the NSE India showed that India’s average cost of equity is at around 14%, declining from around 15% three years ago.

Cheaper funds coupled with various other relief measures such as loan moratoriums and credit-linked schemes helped prevent defaults in a year of massive economic distress.

The overall annual default rate declined from 4.5% in FY20 to 2% in FY21, showed an analysis of over 8,000 corporate entities across sectors by Crisil Ratings and Research. The absolute number of defaults declined by over 60% in FY21.

Somasekhar Vemuri, senior director at Crisil Ratings Ltd, is cautiously optimistic on the overall credit quality for FY22 on the back of the expected improvement in economic growth and pick-up in the pace of vaccinations. However, he warned of downside risks emerging from a potential third wave of covid-19 infections.

“Also, while the monsoon has progressed well so far, any issues with the spread and intensity of the monsoon going ahead could affect rural incomes, thus impacting the system’s credit quality and ability to repay loans,” he added.

Apart from these, an early interest rate hike by the US Federal Reserve could also be a party pooper for Indian companies. At its recently held meeting, the US Fed hinted at an interest rate hike in 2023, one year earlier than previously assumed.