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RatingsDirect
India's Top Companies Set To Gain Even As China's Continue To Feel
The Pain
02-Aug-2016

India has edged out China as the world's fastest-growing economy, despite a slowdown in global growth and tough
times for many emerging markets. But both countries remain significant powerhouses--albeit with different forms of
government and economic systems. S&P Global Ratings' comparative analysis of India's top 200 companies (by market
capitalization) against their Chinese counterparts highlights the effects of these differences on the credit risks of those
companies and the overall corporate sector in the two countries.

Our analysis showed that government influence is far greater for listed companies in China than in India, where the
private sector dominates. This directly affects companies' flexibility to reduce capital spending, when it may be
advantageous to do so. Higher government influence also generally results in weaker profitability and eventually shows
up in higher leverage. But this does not mean that the credit risk is always higher. In many cases, government-related
entities (GREs) benefit from extraordinary government support and better access to the banking and financial sectors.

Overview

Private entities dominate the top 200 Indian companies by market capitalization, accounting for about 75% of
net debt and EBITDA, compared with less than 20% for the top Chinese companies.
Leverage has peaked for Indian companies but continues to increase for Chinese GREs. But India faces the risk
of debt concentration, with about 15% of the companies in the sample accounting for 60% of net debt, as well
as high borrowing costs.
Indian private companies outperform both the Indian GREs and Chinese companies by registering the highest
(and relatively stable) returns. Their performance reflects the presence of asset-light industries and the
nimbleness of private companies to adapt to the external environment.
Capital expenditure has generally peaked in both India and China, but Chinese private companies continue to
increase spending from a small base.
We believe credit risk has peaked in India, whereas we expect it to increase in China over the next three years.

In India, Private Companies Rule The Roost

In our view, the role of the private sector is the biggest differentiating factor between the top companies in India and
China. In India, the private sector accounts for about 90% of the companies in our sample and about 75% of the EBITDA
and net debt (see chart 1). In China, on the other hand, the government continues to play a dominant role in the
corporate sector, and the contribution of the private sector to net debt is minimal. We believe this minimal net debt
contribution reflects two factors: one, the Chinese private sector's concentration in mainly asset-light industries such as
consumer discretionary, healthcare, and information technology compared with a much wider distribution in India; and
two, the Chinese private sector' challenges and limitations in access to financing, especially from the dominant
government-owned banking sector.

Chart 1

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We believe the significant difference in the size of the private sectors in India and China will play an important role in the
top companies' future operating and financial strategy and performance. It will influence their capital spending, funding
sources, access to financing, profitability, and financial leverage. At the same time, private companies do not benefit
from extraordinary government support, which can also play a significant role in determining their credit risk--particularly
when it involves a highly-rated sovereign such as China.

In our analysis, we have considered companies with more than 50% of government shareholding in India as (GREs),
whereas, in China, we have used 20% as the threshold. This reflects our view of the extent to which the government in
each country can influence companies depending on its shareholding. We also note that net debt for the Indian
companies in our sample could be somewhat higher than what is indicated for fiscal 2016 (ended March 2016) due to
certain disclosure limitations in the absence of detailed annual reports.

Chinese GREs' Leverage Continues To Climb, But India's Private Sector Faces
Greater Risk Concentration
Leverage has been building up for Emerging Asia for the past several years, and China and India are no exceptions.
Large companies in both these countries have invested in new capacity but external and domestic economic conditions
have not been supportive. The result is that leverage has steadily climbed and mainly in capital-intensive sectors such
as utilities, infrastructure, and metals and mining. However, we expect the tide to turn in the private sector, especially in
India. Private companies base their decisions on their own economic and strategic case and their own financial position.
They generally are not influenced by government rhetoric, and nor do they benefit from government support. They are
therefore the first to adjust to changes in the external environment. The case for Chinese GREs is different. These
companies continue to invest in infrastructure and projects with large lead times because of the push from the
government. We therefore believe that the industrywide leverage for the top Chinese GREs will continue to increase
(see chart 2).

Chart 2

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In addition, more Indian companies have conservative financial leverage (a ratio of net debt to EBITDA of less than 2x)
and the number of companies with very high leverage (a ratio of net debt to EBITDA of more than 5x) is also lower than
for China. But this doesn't mean that the risk for financial intermediaries such as banks is lower. Indian companies' debt
is highly concentrated: Less than 15% of Indian companies account for more than 60% of the net debt (see chart 3). In
addition, only a small portion of these companies are GREs that will benefit from some level of government support in
case of financial distress. Therefore, the risk to the financial sector emanating from financial stress at any leveraged
company is higher, as the recent deterioration in Indian banks' asset quality shows. The concentration also affects, in
some cases, corporate entities' access to funding from banks on account of single-borrower or group limits. In contrast,
75% of the Chinese top companies in our sample with very high leverage are GREs. This means that the GRE's link and
importance to the government will need to be assessed to determine the ultimate credit risk for these Chinese GREs.

Chart 3

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Profitability Is The Differentiator As The Growth Trend Is Yet To Diverge

Operating performance is one parameter in which private companies have been outdoing their GRE counterparts in the
past few years, and we expect this to continue. And this is generally true even though GREs get preferential access to
many resources and benefit from legacy advantages that underpinned a good market position. But they miss out on the
nimbleness and efficiency orientation of the private sector.

Revenue growth for companies in both India and China is trending down (see chart 4). Much of the negative growth in
2015 reflects the impact of falling prices on large commodities companies in the sample, but the trend is broadly
declining even after excluding these companies. This reflects the subdued economic environment in the respective
countries. In our view, the declining growth trend for the top Indian companies has bottomed out and growth will likely
improve over the next two to three years. A better operating environment with increasing government spending and a
likely improvement in the domestic economy will support growth. The outlook for the Chinese companies' revenue
should stabilize for the next 12 months, with sustained spending on infrastructure and an improvement in housing
construction. Nevertheless, growth will come under pressure if policymakers slow credit growth to control rising
corporate leverage.

Chart 4

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Return on capital, a measure of profitability, has generally been declining for Indian GREs as well as Chinese GREs and
private companies. Indian private companies are the exception, and have maintained their return on capital within a
narrow band (see chart 5). This is partly because of the good performance of asset-light sectors such as information
technology and pharmaceuticals, and the auto sector. In addition, going forward, we expect profitability to improve,
particularly for companies in capital-intensive sectors. This is because companies are focusing on improving capacity
utilization and operating efficiency, and domestic economic conditions are likely to improve. This is unlike their Chinese
counterparts, which have been consistently registering a decline in returns. Chinese private companies have been
following the trend of Chinese GREs, but for different reasons. Increased competition has crimped margins for private
companies while sustained heavy investments in long-term projects such as subway and railway systems weighed on
GREs' returns. Also, downward pressure still remains because of significant overcapacity in some industries. For
example, tariffs for high-speed rail are set low to ensure affordability at the expense of the operator's profitability. We
believe cost-cutting measures can only partly ease the pressure on returns.

Chart 5

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Capex Has Generally Peaked Across India And China

The effects of the subdued economic environment are starting to show in companies' capital expenditure (capex).
Companies are beginning to reconsider new capacity expansion plans and are putting them on hold, especially in the
commodities sector and in India's private sector (see chart 6). The slowdown in capital spending in the Indian private
sector also reflects the weak financial position of many companies in capital-intensive sectors, along with the challenges
facing the banking sector. We currently do not have the information for Indian companies for fiscal 2016 but expect the
trend to continue. In fact, we do not expect a revival in capital spending for the next 12-15 months.

Chart 6

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Companies' reviewing capex does not necessarily mean that it will decline significantly, because companies continue to
invest in projects that are already underway. In addition, the Chinese government's push on infrastructure and the Indian
government's desire for higher investment will limit the ability of GREs in both countries to materially scale back capital
spending. Capex at Chinese private companies continues to increase although it remains low as a proportion of
revenue. This is mainly because of the technology and services sector, which benefits from the government's focus on
rebalancing the economy to consumption-driven from investment-led. Chinese private companies' capital spending is a
much lower proportion of their revenue compared to that of Indian private companies, which have a sizable presence in
capital-intensive sectors as well (see chart 7).

Chart 7

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Higher Cost Of Borrowing Adds To Pressure For Indian Companies

India suffers from a high interest rate environment when compared with other emerging Asian economies. The difference
is starker when compared with China, with the gap widening. This reduces the debt servicing ability of leveraged
companies in India and can result in financial stress. The gap in the EBITDA interest coverage of Indian and Chinese
companies despite their somewhat similar leverage reflects this (see chart 8). At the same time, interest coverage has
been consistently weakening in both countries over the years as leverage increases.

Chart 8

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In our opinion, the widening gap between the cost of borrowing in India and China reflects the policy rate trend. In India,
the policy rates were raised by 375 basis points (bps) compared with 125 bps in China within a period of almost two
years between 2010 and 2012. It also reflects better rate transmission in the system by China when both countries
lowered policy rates by about 150 bps over the past 18 months.

In our analysis, we adjusted interest expenses to include capitalized interest. However, the quality of disclosures limits
our ability to do this comprehensively. Also, fiscal 2016 information is not available for most Indian companies.

India And China Are Headed In Different Directions

The credit cycles in India and China are at different stages. More importantly, we see them moving in opposite directions
in the next two to three years.

We believe that in India, the credit risk has peaked and will only lessen from here on. It may not appear that way if one
were to look at the asset quality pressure in the Indian banking sector. But that's more a combination of the central
bank's asset quality review and also partly a lag issue. We believe the improvement in credit risk will be due to several
factors--better economic environment, higher capacity utilization, lower capital expenditure, and focus on deleveraging.

The same is not the case for China though. We believe credit risk in China is going to increase over the next two to three
years with excess capacity eroding profitability. This, combined with significant debt-funded new investments, is
increasingly putting pressure on the financial leverage of companies. The strain is also reflected in rising defaults,
especially in the onshore bond market. The government factor does help, but it's not a surety against default as we have
already seen for some Chinese GREs. With the government trying to rebalance the economy, the changing support from
the government toward GREs, and more than 100,000 GREs, Corporate China could be in for a rough ride.

Only a rating committee may determine a rating action and this report does not constitute a rating action.

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Primary Credit Analyst: Mehul P Sukkawala, CFA, Singapore (65) 6239-6337;

Secondary Contacts:
Research Assistant:
mehul.sukkawala@spglobal.com
Christopher Lee, Hong Kong (852) 2533-3562;
christopher.k.lee@spglobal.com
Abhishek Dangra, FRM, Singapore (65) 6216-1121;
abhishek.dangra@spglobal.com
Congyun Zhou, Singapore

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