Excess corporate debt a medium-term risk to India’s growth trajectory: IMF

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New Delhi: Excess debt on the books of Indian companies remains a medium-term risk to India’s growth trajectory, the International Monetary Fund (IMF) said on Wednesday.

Excess corporate debt also increases risks to banks, IMF said in its Global Financial Stability Report. “Banking systems are vulnerable to further declines in growth or profits, particularly in countries at later stages of the credit cycle (such as India), where slowing credit growth and risks from elevated levels of non-performing loans are most acute,” it said.

While political instability in many countries such as Brazil, Turkey and South Africa have impacted their macro-financial stability, “India continues to benefit from a stable political environment”, IMF said.

IMF said though growth expectation for India for 2016-17 has been revised slightly higher to 7.6% from 7.4% projected earlier, medium-term macroeconomic challenges remain. “External conditions may turn less supportive if US dollar strength resumes, perhaps as a result of renewed expectations for higher rates in the United States, which could test the resilience of emerging market economies again,” IMF said, without naming India.

For countries like Brazil, China, India and Indonesia, higher funding costs and lower corporate earnings could result in significantly higher debt-at-risk for non-financial firms, the agency said.

“A shock to earnings growth consistent with the continuation of subpar performance as in the most recent two years, and a permanent increase in debt risk premiums over the next five years, increases the debt-at-risk substantially for many economies,” it added.

IMF said the additional potential losses from an adverse deleveraging scenario would require additional provisions for many banking systems. “Pressure is more acute where loan-loss reserves are low relative to potential losses, such as in India, Indonesia, and South Africa,” it added.

Loan loss reserves are accounting entries banks make to cover estimated losses on loans due to defaults and non-payment.

IMF said policymakers should proactively monitor and address corporate vulnerabilities, particularly those arising from excess leverage. “Swift and transparent recognition of non-performing assets is central to ensuring future banking system health,” it said.

New Reserve Bank of India (RBI) governor Urjit Patel in his post-policy press conference on Tuesday said the central bank would be firm but pragmatic in dealing with bad loans.

Praising RBI, IMF said countries like India are taking steps to reduce non-performing loans, but additional and more timely action is needed. “Corporate insolvency frameworks should be upgraded (including by facilitating out of-court settlement and debt-for-equity swaps, with well-defined and transparent rules) and contingency plans to manage corporate distress put in place. This should include a timely, market-based restructuring framework that minimizes moral hazard while providing for limited state support if necessary,” it said.

“Where available, banks should draw on their capital reserves to cushion losses. But where these reserves are insufficient, policymakers will have to balance necessary prudential tightening against the risk of being excessively pro-cyclical,” it added.