FY21 had been a year of despair and surprise. The pandemic unleashed a crippling blow to the economy, with the first quarter spent in extended lockdowns, leaving the economy in devastation. However, the speed at which business were able to evolve to the new reality and the pace of economic recovery from the third quarter have been a surprise.
The year of the pandemic saw India Ratings and Research (Ind-Ra) downgrading [1] 199 issuers and upgrading 147 issuers - the second consecutive year when downgrades exceeded upgrades. However, despite the pandemic, the corporate downgrade to upgrade ratio (D-U ratio) was lower at 1.4 than 1.9 in FY20. Interestingly, the quarterly D-U ratio trend has moved from a high of 2.5 in 1Q, to 0.6 by 4Q, indicating the stress from the pandemic is moderating.
Defaults in FY21 were contained at 2.4%, which was almost half of the previous year.
Arvind Rao, Director Ind-Ra said, “While it may appear counterintuitive to expect a lower D-U ratio in a year which started off with a never-seen-before complete economic shutdown and preceded by a year of unexpected significant economic slowdown, several timely supportive policy measures, sharp economic recovery and Ind-Ra’s exclusive approach to rate amid pandemic uncertainties dictated the rating actions." What however unique to Ind-Ra was the high downgrade rate in FY20, which were clearly ‘ahead of the credit curve’, based on several severe downward revisions to GDP and the continued weak outlook at that time. These early rating actions created sufficient cushion to absorb the stress witnessed in FY21.
Regulatory forbearance by way of the six-month debt moratorium, subsequent one-time debt restructuring, temporary revisions to default recognition norms to credit rating agencies, and liquidity injections into the banking system minimised the risk of a solvency in the affected sectors and helped avoid negative rating actions for several entities.
Supporting the upgrades, particularly from the third quarter, the steeper-than-expected V-shaped GDP recovery was aided by supply-side policy measures and recently addressed demand issues through the union budget. Ind-Ra revised GDP estimates for FY21 upwards by 500bp to negative 7.8% in January 2021. GDP is expected to improve to 10.4% in 2022.
Unique framework for rating amidst uncertainty: Amid the rating uncertainty of during the pandemic, Ind-Ra published its recovery framework in April 2020, which ensured that the ratings actions were not a knee-jerk reaction to the immediate performance, but a calibrated recovery estimate over FY22 and beyond and to an extent resetting the benchmarks across rating categories. For example, the devastation has been so severe that in Ind-Ra's estimate 40% of the rated issuers may not reach their FY19 revenues even in FY22. This would have normally resulted in a very large number of rating downgrades.
However, the rating actions were calibrated based on recovery estimates over FY22 and beyond and also to an extent resetting the benchmarks across rating categories, as the pandemic impact was felt across the board. Ratings were downgraded if the Issuers’ credit profiles suffered a long-term impairment. This led to downgrades in 16% of the reviewed ratings in FY21. Any likely uncertainty beyond the framework was indicated through a negative directional indicator (outlook/ rating watch). During the year, as many as 16% of the ratings were on a negative directional indicator.
Overall revenue loss is expected to be about 12% in FY21 compared to FY19. However surprisingly, the financial metrics have only been marginally dented. This was possible as corporates initially adopted to cost reduction and cash preservation measures while the subsequent increase in sales from pent-up demand and better realisations sustained their profitability.
Rakesh Valecha, Senior Director, said, "While the pandemic impact was pervasive, some sectors bore the brunt of the pandemic and would see a prolonged recovery. Sectors which are classified as essentials, such as pharma and healthcare, and who had operated through the lockdown, witnessed limited disruptions and saw fewer downgrades at 9% of the reviewed ratings. Recovery was also the fastest for such issuers, with upgrades at 20%. Issuers in the Discretionary bucket belong to sectors such as airlines, airports, real estate, hotels, saw immediate and severe demand destruction. They are also witnessing the slowest pace of recovery. Not surprisingly, downgrades were the highest at 25% and upgrades were limited to just 5%." Issuers classified under the Non-discretionary and Industrials buckets saw their prospects in between these two buckets. Rating of financial institutions saw a minimal impact, as they had timely liquidity access, capital infusions leading to correction of ALM mismatches.
The primary reason for ratings downgrades had been the impairment of business profile, with revenues not likely to be recouped over the projected period. Upgrades were not generally triggered by the improvement in operating performance related factors but more from factors such as completion of capex or acquisition by a strong parent. Wherever operational performance was the driver for rating upgrades, these issuers had seen a significant reduction in their debt levels.
As in any crisis, the vulnerable sub-investment grade ratings were impacted significantly and saw almost 5x as many downgrades at almost 36% of the reviewed ratings compared to the ‘A’ category and above ratings. Rating actions in the BBB category were moderate than the sub-investment grade counterparts.
Expectations for FY22: Clearly, the pandemic has left deep scars, with a meaningful recovery expected only in 2023. As we step into FY22, with a sense of déjà vu - a resurgent second wave of infections creeping in the fag end of FY21, a disruptive lockdown is unlikely to be imposed, given that low mortality and the severity of economic cost. Ind-Ra's rating actions and projections have not factored in major disruptions, while it remains an important emerging factor to be watched out for. Weakened government finances with a likely uncomfortable deficit of 6.2% in FY22, hardening yields, ensuing risks from commodity price increases and sustenance of demand drivers are primary sources of concern for FY22.
As many as 14% of the rating carry a negative directional indicator at end-FY21. These were assigned to capture residual unknown risks and are likely to be moved to stable, given the pace of improvement seen in the credit profiles over the last quarters. These issuers are still at risk and could be the first ones to get impacted, if the recovery falls short of expectations. Rating actions in FY22 will remain a cautionary tale, but a revival in upgrade fortunes is more likely.
