In addition, the central government has revised the definition of MSMEs to include entities with revenue up to INR2.5 billion and investment in fixed assets up to INR500 million. This will enhance the freshly included MECs’ ability to access fresh funding from the financial system – on account of the inclusion of the banking sector’s exposure to these issuers in the priority sector exposure bucket. Ind-Ra in its FY21 Mid & Emerging Corporate highlighted that over FY19-FY20, access to funding has been the single-largest challenge for MECs in India – especially in the aftermath of the challenges faced by the non-bank finance company (NBFC) sector.
Ind-Ra’s rating actions reflect the agency’s through-the-cycle expectations and thus despite these relief measures, a significant portion of the rated universe could still test their negative rating sensitivities. In scenarios where the impairment in the business profiles and balance sheets is not expected to reverse in the near term, then the risk of a negative rating action could be high. Ind-Ra believes that notwithstanding access to funding under the schemes, entities may find it difficult to revert to their pre-COVID profile. Therefore, negative rating actions could stem from liquidity pressures or deterioration in long-term profile or a combination of both. The extent of benefit on account of the government’s schemes will depend on their timely implementation – especially with regard to putting in place proper systems and processes to ensure smooth functioning of these schemes over the near to medium term.
Rating Actions on Rated MECs: Between April 2020 and 15 June 2020, Ind-Ra downgraded 25 rated MECs while upgrading six issuers. For 44% of the issuers, the rating downgrade was primarily reflective of the COVID-19 related business disruption while for the remaining issuers the pandemic has aggravated the existing cash flows pressures. Even before the pandemic, Ind-Ra’s downgrade to upgrade ratio for the MEC portfolio, increased to 2.85x in FY20 from 1.28x in FY19. Although various regulatory and centre dispensations could keep downgrades in check in the near term, a protracted economic recovery could result in a significant rise in negative rating actions post the expiry of these forbearances.
Lower Rated MECs to Primarily Benefit from Collateral-free Loan: Ind-Ra has analysed around 200 investment-grade rated MECs and 226 speculative grade MECs[i]. Of this, 131 issuers are eligible for the INR3 trillion collateral-free loan – of which 91% are rated in the speculative grade. This loan is available only to those MSMEs which carry an outstanding debt of up to INR250 million and revenue up to INR1 billion.
Ind-Ra’s analysis indicates that issuers with a weak liquidity profile - i.e., FY19 cash flow from operations (CFO) interest cover below 1x - comprise 47% of the eligible issuers while another 14% are likely to report a CFO interest cover above 1x but less than 2x. In case of the remaining 39% of the issuers with a stronger liquidity profile, access to this funding window could enable to refinance their high-cost liabilities. The agency believes that the interest cost differential could range between 200-400bp for its rated issuers.
For the majority of the issuers with a weak liquidity profile, the incremental funding accessible via this window (i.e., 20% of existing debt) could account for over 180 days of EBITDA and thus provide a meaningful liquidity cushion and thereby avert any near-term pressure on their rating. Figure 2 represents the extent of relief for Ind-Ra’s rated eligible MECs by assessing their liquidity profiles and the quantum of debt accessible via this window in relation to their annual EBITDA.
Revised MSME Classification to Enhance Financial Flexibility: Ind-Ra’s analysis indicates that around 60% of its rated MEC issuers are eligible for MSME classification under the new norms. In particular, 80% of the issuers rated below investment grade would be eligible.
The agency views that this will augment the rated issuers’ financial flexibility quite significantly. In particular, advances to issuers registered as MSMEs are eligible loans towards meeting priority sector loan (PSL) targets for Indian banks. Although over the last five years bankers have been risk averse and credit growth to the non-PSL MSME segment has averaged at less than 1% yoy, while PSLs have grown at an average of 7%.
In particular, large MSMEs could receive a larger share of PSLs, given that the historically higher delinquencies in advances to micro and small enterprises than that for the entities with revenues in excess of INR1 billion. This could also stoke funding by NBFCs to MSMEs. Loans eligible for PSL classification can easily be securitised by NBFCs (after a minimum holding period) and both foreign and domestic banks have been large investors in such transactions - via pass through certificates and direct assignments, respectively. This, therefore, could also ease the cost of funding for the MECs eligible to be classified as MSMEs.
Subordinated Debt Scheme Could Provide Some Respite to Stressed MSMEs: A sustained build-up of stress in the MEC universe has resulted in Ind-Ra maintaining a negative outlook on this segment for FY21. Between September 2019 and April 2020, the proportion of rated MEC universe in default increased to 18% from around 10%. The agency believes that the decision to provide funds to the promoters to infuse capital in stressed MSMEs could help reinvigorate some of these stressed units – especially those which have been facing a funding gap for a long time. However, a long-term absence of deep meaningful, structural reforms could intensify liquidity challenges for MSMEs.