Tag Archives: Fitch Ratings

India’s reforms could support medium-term growth

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Hong Kong: Fitch Ratings believes that the revival of the central government’s reform agenda in response to the coronavirus pandemic shock has the potential to raise India’s medium-term growth rate. Nevertheless, there are also downside pressures to growth and it will take time to assess whether the reforms are implemented effectively.

In recent years, the Indian authorities’ strategy to keep the public debt ratio and broader public finances under control has relied heavily on expectations of sustained rapid nominal GDP growth. The pandemic will slow medium-term growth, as we believe damaged corporate balance sheets will dampen investment for years. Renewed asset-quality challenges in banks and generally fragile liquidity for non-bank financial companies could also constrain growth prospects and jeopardise the stability of the medium-term government debt/GDP trajectory.

Raising medium-term growth rates under these circumstances will require reforms to support investment and boost productivity. We noted the GDP growth outlook as a key rating sensitivity when we revised the Outlook on India’s ‘BBB-’ rating to Negative from Stable in June.

Several reforms passed by parliament since the pandemic set in could lift medium-term growth prospects. The most notable are agricultural reforms to give farmers more flexibility over where to sell their produce. Stripping out middle men, as the reform allows, could improve farmer incomes while reducing consumer prices. Nevertheless, implementation risks are significant. For example, segments of the farm lobby have protested the reform, apparently over fears that it could result in the abolition of minimum support prices, although the government says this will not happen.

Parliament has also passed labour reforms. Their intent, among other things, is to improve worker access to social security (notably in the large unorganised sector), strengthen occupational safety requirements, speed up the resolution of labour disputes and ease migrant workers’ ability to move between states. In addition, employers will now only need prior state government approval for redundancies if they have over 300 workers, up from 100 previously, and state governments may raise this threshold. These changes could support formalisation of India’s labour market and improve its flexibility, with positive efficiency gains, but our assumption is that in practice their impact will be modest.

The government also intends to privatise some state-owned enterprises, of which more than 200 are owned by the central government and 800 by state governments. A wide-ranging privatisation push involving large SOEs could be transformative. However, it remains unclear whether the government plans to surrender its majority control. The strength of market demand for state assets is also yet to be tested.

We expect the central government to remain generally reform-minded over the next few years, while reforms also take place at the state level. Some states, for example, have passed land acquisition reforms, after the central government was unable to find sufficient support on this issue for approval in India’s upper house, the Rajya Sabha, in 2015. State-level reforms will remain important, even if their impact is more geographically limited.

The process of reform in India remains especially complex and implementation at times has proven difficult. In recent years, the government has opened more sectors to FDI, but also raised international trade barriers and withdrawn from the Regional Comprehensive Economic Partnership before its recent agreement was secured. Meanwhile, two landmark reforms from the government’s previous term faced set-backs recently due to the pandemic. The Insolvency and Bankruptcy Code has been suspended temporarily in line with forbearance regulations for banks, while a decline in inflows from the Goods and Services Tax will make it more challenging to divide these revenues among the centre and the states.

Indian Automakers’ Challenges to Persist After Weak 1Q: Fitch Ratings

Mumbai/Singapore: Subdued demand conditions that led to weak performance by Indian automakers in the first quarter of the financial year ending 31 March 2020 (FY20) will likely persist, adding to the challenges from the implementation of stricter emission norms under BS6 from April 2020, says Fitch Ratings. Most auto OEMs reported lower volumes and profitability in 1QFY20 as domestic sales volumes of passenger vehicles and medium and heavy commercial vehicles fell by 18.4% and 16.6%, respectively, according to the Society of Indian Automobile Manufacturers.

Domestic sales trends have weakened since 1HFY19 as the constrained liquidity at non-bank lenders reduced credit availability to buyers and the cost of ownership rose due to new regulations mandating enhanced vehicle insurance cover and additional safety features. In addition, the sales volume of commercial vehicles was also affected by easing in axle load standards in July 2018, which resulted in additional freight capacity in the system. The decline in sales in 1QFY20 was much sharper as it coincided with India’s general elections in April and May 2019. Monthly volumes weakened further in July 2019 with yoy decline of more than 25% each in the passenger and commercial vehicle segments.

Sales volumes in the two-wheeler segment have been more resilient than passenger and commercial vehicles due to their lower prices and non-discretionary demand, particularly in rural areas where they serve basic commuting needs and enable income. Nonetheless, volumes fell by 11.7% yoy in 1QFY20 and 16.8% in July 2019.

We expect overall domestic auto sales volume to decline in FY20, although volumes may stabilise in the coming quarters due to government’s focus on improving liquidity at lenders and recent measures to revive auto demand. The improved likelihood of adequate rainfall and recent cut in interest rates should also help demand in 2HFY20. However, the lower volumes will weigh on automakers’ profitability in FY20 and could offset the benefits from lower commodity prices.

The implementation of BS6 emission standards will require automakers to make changes to vehicle platforms ahead of March 2020 – the regulatory deadline after which sale of older models will not be allowed. This will require significant investments to upgrade existing vehicle models and assembly lines, which will put pressure on free cash generation. Automakers will also need to realign their portfolios, particularly for the diesel variants of smaller cars, which will cost more to move to BS6 compared with ‘cleaner’ petrol variants. This could lead to changes in the competitive dynamics in the mass segment.

Fitch estimates the additional components and design changes will raise production costs by 10%-15%. This could squeeze automakers’ profitability in FY21 if automakers are not able to fully pass on costs to buyers. Increased vehicle prices after March 2020 could spur some buyers to bring forward their purchases, but we do not expect this to be material. Automakers appear to be cautious about production and inventory management amid weak demand conditions, and they have announced production and work force cuts.

Weaker auto sales volumes are likely to have a bigger impact on auto suppliers, especially the smaller and less diversified players that have lower bargaining power in negotiating prices and passing on input price volatility. Motherson Sumi Systems Limited (MSSL) enjoys strong market position in its wiring harness business in India and its diversification outside India through its subsidiary Samvardhana Motherson Automotive Systems Group BV (SMRP BV, BB+/Stable) will help to alleviate the impact of weak demand in India. Nonetheless, SMRP BV remains exposed to slowing auto volumes globally, with profitability, excluding recently set up plants, narrowing during 1QFY20.

Tata Motors Limited’s (TML, BB-/Negative) sales volume fell by more than 20% yoy and profitability weakened for the Indian business in 1QFY20. This was driven by a 16% fall in commercial vehicle volumes that was in line with the industry trend and a sharper 30% drop in passenger vehicle sales volume. Consolidated volumes and margins were affected by challenges at wholly owned Jaguar Land Rover Automotive plc (JLR, BB-/Negative). Fitch’s recent one-notch downgrade of TML factors in weakness in India and the JLR business, and the Negative Outlook underscores limited rating headroom due to a large investment plan and risks in JLR.

US-China Trade War Escalation Could Knock 0.4pp Off World GDP by 2020: Fitch Ratings

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The imposition by the US of 25% tariffs on the remaining USD300 billion of imports from China would reduce world economic output by 0.4pp in 2020, Fitch Ratings says. Global GDP growth would slow to 2.7% this year and 2.4% next year, compared with our latest “Global Economic Outlook” baseline forecasts of 2.8% and 2.7% respectively. China’s growth rate would be reduced by 0.6pp, and US growth by 0.4pp, in 2020.

The imposition of tariffs on all imports from China being considered by the US administration would mark a significant escalation of trade tensions. It would see the US levy tariffs on an additional USD300 billion worth of goods. Presidents Trump and Xi both said last week that trade talks would resume at the upcoming G-20 meeting, where they planned to meet in person.

Fitch’s economics team has assessed a scenario in which the US imposes import tariffs at 25% on USD300 billion of goods from China and China retaliates by imposing a 25% tariff on USD20 billion of US imports untouched by the trade war so far, and by raising the tariff rate on USD100 billion of US imports already subject to new tariffs to 50%. The scenario also assumes that China cuts interest rates by 50bp and allows the CNY to depreciate by 5% relative to our baseline. The Fed responds by cutting rates. Our analysis used the Oxford Economics Global Economic Model – a global macroeconomic model taking into account trade and financial linkages between economies.

For China and the US, the tariffs would initially feed through to lower export volumes and higher import prices, with the latter raising firms’ costs and reducing real wages. Business confidence and equity prices would also be dampened, further weighing on business investment and reducing consumption through a wealth effect. Over the long run, the model factors in productivity being affected as local firms are less exposed to international competition and so would face fewer incentives to seek efficiency gains. Export competitiveness in the countries subject to tariffs would decline, resulting in lower export volumes.

The negative growth effects from lower export demand would be magnified by multiplier impacts on upstream supplier industries and from lower incomes in the export sector. These effects would spill over to other trading partners not directly targeted by the tariffs. Import substitution would offset some of the growth shock in the countries imposing import tariffs.

Global growth would fall even allowing for the monetary policy easing response. While falling short of a global recession, this would be the weakest global growth rate since 2009 and slightly worse than 2012, when the eurozone sovereign debt crisis was at its peak.

Countries not directly involved in the trade war would also see their GDP falling below baseline, though in most cases by less than the US and China. Korea would be the most severely hit, with GDP more than 1pp below baseline in 2020. Net commodity exporters such as Russia and Brazil would be affected, as slower world growth would push oil and hard commodity prices down.

Except in China, this trade war scenario would ultimately be deflationary as lower growth and hard commodity prices would curtail inflation. In the US, inflation would increase relative to the baseline in the year following the tariff hike. However, further out, slower growth, lower commodity prices and a stronger exchange rate would dampen price rises. Only in China would inflation remain above baseline for longer, because of the effect of a weaker exchange rate on import prices.

Fitch downgrades long-term default and viability rating of ICICI and Axis banks

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Mumbai: Fitch Ratings has downgraded ICICI Bank Limited’s Long-Term Issuer Default Rating (IDR) to ‘BB+’ from ‘BBB-‘ and its Viability Rating to ‘bb+’ from ‘bbb-‘. The Outlook on the IDR is Stable. Fitch has also affirmed ICICI’s Support Rating at ‘3’ and Support Rating Floor at ‘BB+’. A full list of rating actions is at the end of this commentary.

Fitch also has downgraded the Long-Term Issuer Default Rating (IDR) and Viability Rating of Axis Bank Ltd. to ‘BB+’ and ‘bb+’, respectively, from ‘BBB-‘ and ‘bbb-‘. The Outlook is Stable. Fitch has also affirmed Axis’s Support Rating and Support Rating Floor at ‘3’ and ‘BB+’, respectively.

The rating actions vis-a-vis ICICI Bank come amid the challenges the bank faces in its operating environment. Fitch lowered its midpoint for India’s operating environment to ‘bb+’ from ‘bbb-‘ following a review of the banking sector’s performance, particularly in the last three years, and its regulatory framework, as well as the outlook in the near term. We also compared India with other sovereign jurisdictions in Asia rated in the ‘BBB’ category including the key metrics of GDP per capita and the ease-of-doing-business ranking. We concluded the sector will perform below the average of its peers over the next one to two years in spite of our expectations of high economic growth and improving business prospects in India. The banks – which remain the biggest credit intermediaries – are positioned to take advantage of this opportunity provided their damaged balance sheets are remediated sustainably with fresh equity that encourages them to support growth in a meaningful way.

Fitch believes the performance of Indian banks should have largely bottomed out, but the sector is still struggling with poor asset quality and weak core capitalisation. We estimate that Indian banks’ impaired-loan ratio declined to an average of 10.8% by 9MFYE19 from 11.5% in the financial year ended March 2018 (FY18), which continues to be high by global standards. Capital buffers are assessed by Fitch as moderate, including for private-sector banks, especially in light of their high impaired-loan ratio, risk appetite and the challenging but competitive operating environment.

The Long-Term IDR on Axis is driven by its Viability Rating, which is the same as its Support Rating Floor. The Stable Outlook on its IDR reflects our expectation of limited downside pressure on the IDR in the foreseeable future.

The bank’s Support Rating of ‘3’ and Support Rating Floor of ‘BB+’ reflect Fitch’s expectation that it is less likely to receive extraordinary state support, if required, than the large state banks (with SRF of BBB-) due to its private ownership. Fitch believes that the sovereign’s constrained finances and the large number of majority government-owned banks that are systemically important and have weak capitalisation means that these banks will have priority in terms of timeliness of government support. The state has a track record of supporting systemically important banks, which we view Axis to be, although Axis has not required support in the past.

The downgrade of Axis’s VR reflects its relatively weak core capitalisation and asset quality, which, despite some improvements in the near term, are not commensurate with Fitch’s expectation of higher rated entities in operating environments viewed as broadly comparable to that facing Indian banks.

Fitch believes that Axis’s core capital ratio is unlikely to meet the threshold for higher-rated banks even if the bank proceeds with the conversion of USD400 million of warrants into equity and fresh equity issuance in the near term. Axis’s Fitch Core Capital ratio of 10.7% and common equity Tier 1 ratio of 11.3% at FYE19 are lower than comparable private banks in India and global benchmarks, which renders Axis vulnerable to shocks or further deterioration in the operating environment.

Axis’s impaired loan ratio improved to 5.8% by FYE19 from 6.8% a year earlier. This compares well against some local private banks, but is still well above Fitch’s expectation for higher rated banks, and we do not expect Axis to reach that level in the near term. Earnings slightly recovered in FY19, but operating profit/risk weighted assets was subdued at 1.3%. We see potential for a stronger earnings recovery in FY20 in line with management’s guidance, but this is likely to entail above-sector growth and potentially higher risk appetite. The risks may be mitigated by the bank’s initiatives in risk management and control.

Axis’s VR also takes into account its retail franchise, which compares well against other Indian banks and reflects its stable funding profile (low-cost deposit ratio of 44% at FYE19).

Axis’s senior debt ratings have also been downgraded to ‘BB+’ from ‘BBB-‘ in line with the IDR, as the debts represent the bank’s unsecured and unsubordinated obligations.

Rating Sensitivities


Axis’s IDR is still driven by its VR. An improvement in the bank’s VR would lead to an equivalent increase in the IDR. However, there is limited downside risk to the IDR in the event of a VR downgrade so long as SRF remains unchanged, implying that our assessment of the sovereign’s ability and propensity to support the bank remains intact.

The IDR is also less sensitive to a downgrade in the sovereign rating as its SRF is lower than the sovereign rating. Similarly, a sovereign rating upgrade would also not lead to an upgrade in the bank’s IDR unless the former coincided with a strengthening of the sovereign’s ability and propensity to support the bank, in Fitch’s view. However, we do not expect that in the near term.

Any changes in the bank’s IDR would result in equivalent changes in their senior debt ratings.

Further improvement in Axis’s impaired loan ratio and earnings would add stability to its VR. However, the VR may not be upgraded until Fitch is confident that its capital buffer can be sustained at significantly higher levels so that there is more than a moderate cushion against risks common in a challenging operating environment. Substantial injections of fresh equity in the near term will help bolster the capital buffer, providing that it is also accompanied by continued improvement in other areas, such as the impaired loan ratio (to significantly lower than 5%) and profitability, without the bank also increasing its risk appetite.

Axis’s VR, which is below the sovereign rating, would be unaffected by a sovereign downgrade, unless it represented further significant deterioration in the operating environment and there were also lingering pressures on the bank’s financial profile.

Any changes to Fitch’s assessment of the government’s propensity and ability to support Axis, based on the bank’s size, systemic importance and ownership, would affect the Support Rating and Support Rating Floor.

Environmental, Social and Governance (ESG) Issues: Axis’s financial transparency is scored ‘4’ on Fitch’s ESG scale. It reflects our view that the quality and frequency of financial reporting and the auditing process have an impact on its VR, which in turn drives the IDR. Axis’s sharp financial deterioration in recent years was driven mainly by regulatory audits that forced the banks in India to recognise non-performing loans (NPLs) after the NPL ratios of banks and the regulator diverged.