Govt may redefine 'cash flow' to aid ratings of infrastructure firms

The government has given a sympathetic hearing to industrial groups that are unable to sell banks their debt paper with a rating lower than double A. 

The companies, mostly in the infrastructure sector, are unable to raise their ratings above A. They have asked the finance ministry to prod banks to buy debt paper more aggressively than they have done.

The problem is the companies’ cash flow. In response the ministry is considering an option to bring more elements in their balance sheets to be counted towards calculating their cash flow. In his Budget 2018-19, Finance Minister Arun Jaitley appealed to banks and other financial institutions to consider investing in A-rated debt paper.

“In India, most regulators permit bonds with the ‘AA’ rating only as eligible for investment. It is now time to move from the ‘AA’ to ‘A’ grade ratings. The government and the regulators concerned will take necessary action,” he said. As it is part of the Budget speech and therefore an assurance to Parliament, the finance ministry is keen to honour the assurance. 

The reason why infrastructure paper does not climb the investment grade to the top notch is mostly because the projects for which it is raised take longer to generate returns. 

Delays in expected returns force the agencies to give them less than a sterling rating.

The companies cannot convince rating agencies that their subsidiaries merit a higher rating than is being offered. Banks and mutual funds, despite sitting on a cash pool, plead helplessness in picking up paper that does not qualify to be “top grade investment”.

Their other avenue of raising money, credit from the banking sector, is getting squeezed. 

As banks try to work through their pile of bad debts, the RBI data shows as of March 30, 2018, the banks’ credit to the sector stood at Rs 8,909 billion, which is 1.7 per cent less than the exposure a year before. In two years, the exposure has contracted by Rs 739 billion.

Meanwhile, infra companies form the largest chunk of those headed for bankruptcy court. The finance ministry wants to create an option that would bring the lenders and debtors together. 

An option the ministry is working on is easing the definition of what constitutes cash flow. Yet as established rating agencies are unlikely to change their evaluation scores, the ministry is debating the possibility of setting up a rating agency for infrastructure alone. Among those that have pleaded with the government to rescue them is an airport construction group.

As of now there are differences within the government on whether such changes in definition would work. Even if a new rating agency were to lower the standards and make more receivables equivalent to cash flow, those are unlikely to become popular among banks, particularly when the latter are facing bad debts, particularly due to outstanding loans to the infra sector. 

Deep Mukherjee, visiting professor of finance at IIM Kolkata, said the likelihood of credit loss was fundamentally an economic aspect and should not be treated as a superficial nomenclature issue.

“Tweaking definitions or rules around cash flow does not change the inherent risk profile of the borrowers.”

India’s default rates for A grade paper are much higher than global investment grades. An India Ratings study on default trends among Indian companies shows in 2016-17 the investment-grade default rate was at 1.1 per cent while the sub-investment grade default rate was at 2.7 per cent. It is above the mean rates globally, which implies that even at higher grades there are more slippages.

For investors, any change in the basis of this evaluation could make it riskier for them to invest in Indian-origin debt paper.

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