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India’s GDP grew by a nine-quarter high of 8.2% in Q1 of FY2019; the growth of gross value added (GVA) at basic prices too increased to 8.0% from 7.6% in Q4 FY2018. Manufacturing, construction and public administration were the key growth drivers, while the former two sectors benefitted from the favourable base effect, the extent to which Government spending can continue to prop up growth in the remaining part of the year remains to be seen. While consumption growth continues to be strong, we feel that rising bond yields, higher commodity prices and the likely trade wars are the possible constraining factors. Also, real estate and the industrial capex is yet to pick up meaningfully. Accordingly, ICRAs estimate for FY2019 GDP growth has been revised only marginally upwards to 7.2% from our earlier estimate of 7.1%.

The Indian corporate sector has posted a strong revenue growth of 17.2% for Q1 FY2019 compared to Q1 FY2018. Based on ICRA’s sample, around 660 companies and 26 out of the 32 sectors showed broad-based revenue growth. While the growth has been achieved on a low base, since Q1 FY2018 was adversely affected by the GST implementation, it is noteworthy that apart from the consumer-oriented sectors, capital goods and pharmaceuticals have also recorded decent performances. Sectors which saw significant erosion in margins included airlines, cement, telecom and sugar. Overall, the Operating Profit Margin of our sample set increased by around 130 basis points and there was a marginal improvement in aggregate interest cover as well.

We also evaluate the impact of the increasing oil prices and the depreciating rupee on the oil and gas sector. ICRA estimates that for an Indian basket of crude oil prices at US$75/bbl and INR/US$ exchange rate of 71, the total under-recoveries on sensitive products could be in the range of Rs 46,000-48,000 Crores , as against a budget of Rs 24,900 Crores . While the GoI has not yet imposed any burden on the upstream oil companies, any adverse development on the under-recovery sharing mechanism would be a key sensitivity in terms of profitability and credit metrics of the companies in this sector. Overall the regulatory risks for this sector has increased .

The issue concludes with the regular features: monthly rating updates, upcoming ICRA events, and news features related to the company.

I hope you will find this newsletter useful and informative.

Best Regards

Anjan Ghosh
Chief Rating Officer, ICRA Ltd

 
 
  From ICRA Research
   
  GDP growth posted an upside surprise to 8.2% in Q1 FY2019
 

Growth of India’s GDP (at constant 2011-12 prices) in year-on-year (YoY) terms rose to a nine-quarter high of 8.2% in Q1 FY2019 from 7.7% in Q4 FY2018. Similarly, the pace of growth of gross value added (GVA) at basic prices increased to 8.0% in Q1 FY2019 from 7.6% in Q4 FY2018, led by industry (to +10.3% from +8.8%) and agriculture (to +5.3% from +4.5%), while the pace of growth of services eased mildly (to +7.3% from +7.7%).

Manufacturing was the key driver of industrial growth in Q1 FY2019. The healthy earnings reported by corporates, which partly reflects the base effect related to the transition to the Goods and Services Tax (GST), boosted the GVA growth of manufacturing to 13.5% in Q1 FY2019 from 9.1% in Q4 FY2018.

Led by the waning of the favourable base effect, construction GVA growth declined to 8.7% in Q1 FY2019 from 11.5% in Q4 FY2018. Nevertheless, the pace of construction GVA growth was healthy in Q1 FY2019, in line with the trend in its inputs, like cement and steel consumption, and activity in the infrastructure sector, including affordable housing. However, real estate and industrial capex is yet to pick up and consumer sentiment is yet to recover appreciably.

While the GDP and GVA growth posted an upside surprise in Q1 FY2019, some concerns linger on the sustainability of growth around 8.0% in the remaining quarters of FY2019, given the waning of the favourable base effect, fiscal constraints, as well as risks posed by higher crude oil prices, interest costs and a weakening rupee.

Manufacturing, construction and public administration were the three fastest growing sectors in Q1 FY2019. While the former two sectors benefited from a favourable base effect, which would wane going forward, the extent to which Government expenditure can prop up growth in the remaining quarters of FY2019 without contributing to a fiscal slippage, would depend on revenue buoyancy.

Moreover, despite the out-turn of the monsoons so far, agricultural growth may ease in the quarters ahead, given the high base of the last kharif and rabi harvests. Amid an uneven monsoon, the hikes in minimum support prices (MSP) for kharif crops would boost rural demand but contribute to higher inflation and/or fiscal risks. The improvement in sentiment, staggered pay revision by various state governments and the recent GST rate cuts, would support urban consumption demand. However, there is a risk that higher inflation, related to the transmission of rising prices of commodities such as crude oil, would weigh upon the disposable income of consumers and the margins of producers, preventing a faster pickup of economic growth.

While bond yields have hardened over the last year, the two rate hikes would partly transmit into higher bank lending rates, which may constrain the strength of the investment recovery.

Given the various risks posed by higher commodity prices and interest costs, and the looming threat of trade wars, ICRA expects a shallow recovery in the GDP and the GVA growth in FY2019. Nevertheless, given the higher-than-expected growth print for Q1 FY2019, we have revised our forecast for FY2019 GDP and GVA growth to 7.2% and 7.1%, respectively, from our earlier estimates of 7.1% and 7.0%, respectively.

   
  Corporate sector registers strong revenue growth in Q1 FY2019, however, on a low base
 

The Indian corporate sector’s aggregate revenues have grown by 17.1% during the first quarter (Q1 FY2019), on a YoY basis compared to Q1 FY2018. As per ICRA research, 660 companies in the Indian corporate sector and 26 sectors out of the 32 under coverage, showed broad-based revenue growth. While the consumer-oriented sectors (auto OEMs, FMCG, consumer durables, restaurants and airlines) and commodity-linked sectors (cement, iron & steel and oil & gas) continue to do well, capital goods, pharmaceuticals, media and fertilisers have also witnessed strong revenue growth in Q1 FY2019.

This growth has been achieved on a low base, adversely impacted by the GST implementation in Q1 FY2018 but on healthy consumption-driven demand and a pick-up in infrastructure spending. However, on a QoQ basis, sales declined by 2.4% because of the seasonality in several sectors.

Sectors that witnessed a decent margin improvement were metals and mining (including iron & steel) due to an uptick in commodity prices and the consumer food sector, supported by lower input costs like milk and sugar. Consumer goods, paints, FMCG and auto OEMs expanded their OPM marginally as they partially absorbed raw material price hikes to mitigate the impact. On the other hand, the margins of airlines, tiles and ceramics and the cement sector witnessed significant erosion due to the rising fuel prices, while factors like subdued realisations (sugar), charter rates (shipping), decline in average revenue per user (ARPUs) and the rise in network costs (telecom) too exerted pressure on companies’ earnings.

The overall operating profit margin (OPM) of our sample increased by ~130 basis points to 17.2% in Q1 FY2018, despite rising inflationary pressures on the raw material front. This is attributed to the benefits of operating leverage and price hikes affected by companies across many sectors to offset the impact of the rising fuel and commodity prices. Further, the improvement in profit margins led to a marginal improvement in the aggregate interest coverage ratio of the current sample to 4.5x as compared to 4.2x during the quarter.

   
  Increasing oil prices, depreciating rupee to increase PSU oil & gas regulatory risk
 

The dual impact of the rising oil prices and the depreciating rupee does not augur well for the PSU oil and gas companies as it will increase their regulatory risks. Global oil prices have risen by about 10% over the past two weeks on declining inventories and there seems to be a faster-than-anticipated decline in Iranian exports as the countdown to the enforcement of the US sanctions begins. While China and the EU intend to continue imports from Iran, banking channels and re-insurers are increasingly shying away, leading to a sharp cut in purchases. Accordingly, Iran’s exports are estimated to have fallen by 0.6 million barrels per day (mbd) in August from 2.3 mbd in July. Consequently, the oil markets seem to be pricing progressively in expectation that the US administration would probably not grant waivers this time as it did during the earlier sanctions.

TAs for the rupee, it has depreciated by about 11% against the US dollar since the beginning of this calendar year, owing to its sensitivity to crude oil prices and significant outflows of foreign investment. Due to the high dependence on imports of crude oil to meet domestic consumption, an increase in crude oil prices simultaneously increases the current account deficit, which is weighing down on the Rupee.

As for the rupee, it has depreciated by about 11% against the US dollar since the beginning of this calendar year, owing to its sensitivity to crude oil prices and significant outflows of foreign investment. Due to the high dependence on imports of crude oil to meet domestic consumption, an increase in crude oil prices simultaneously increases the current account deficit, which is weighing down on the Rupee.

ICRA estimates that with the Indian basket crude oil price of $75/bbl and the Re/$ exchange rate of 71 for the balance FY2019, the total under-recoveries on sensitive products could be in the range of Rs 46,000-48,000 crore. Till now, even on under-recoveries higher than Rs 12/litre on PDS SKO and Rs 255/cylinder on domestic LPG, the GoI has not imposed any burden on the upstream companies. However, with the actual under-recoveries exceeding the budgeted Rs 24,900 crore significantly the GoI may impose a burden of Rs 7,000-10,000 crore on the upstream companies.

Any adverse development on the under-recovery sharing mechanism than already factored in, will be a key rating sensitivity for both the PSU downstream and upstream companies. While the marketing profitability of PSU OMCs could be under pressure in the near term, their credit profile is expected to remain stable because of healthy refining margins, rising share of profits from petrochemicals and gas, besides the moderate level of debt leading to healthy credit metrics. As regards the upstream companies, their credit metrics are expected to remain solid even if their net realisation on crude is around $60/bbl after under-recovery sharing.

     
  India’s apparel exports not out of the woods yet; modest growth likely
 

India’s apparel exports are likely to remain subdued in the near term, even as the worst appears to be over. With the base effect setting in, ICRA expects India’s apparel exports to grow at a modest pace of ~1-2% YoY for the rest of FY2019, vis-a-vis a sharp de-growth of ~14% YoY in 4M FY2019. As this would still mean a 4% YoY decline in the country’s apparel exports in FY2019, it is expected to be the fourth consecutive weak year for India’s apparel exports, following the 4% de-growth in FY2018 and modest growth rates of 1% and 3% in FY2016 and FY2017 respectively. India’s apparel exports have exhibited an unencouraging trend, with a marginal de-growth of ~1% in FY2018 as well as 4M FY2019, even after adjusting for apparel exports to the UAE, which have declined inexplicably and sharply over the past one year.

With several internal as well as external headwinds, the past year turned out to be rather challenging for India’s apparel exporters. Transition to the new taxation regime, besides posing liquidity challenges for the industry, added to the uncertainties because of alternating stances on export incentives during the year. Further, a stronger rupee heightened the challenges in the intensely competitive international apparel market.

ICRA research says that the country’s apparel sector’s performance is worrying, being contrary to the global trends. The global apparel trade is back on the growth trajectory with an estimated growth of ~4-5% year-on-year (YoY) in H1 CY2018 (refers to Calendar Year) and 2% in CY2017 in US dollar terms. The positive trend in the global apparel market is being led by the strong recovery in apparel imports by the European Union (EU), which accounts for two-fifth of the global apparel trade (including the trade within the EU).

With faster GST refunds, improved clarity on the rate of export incentives and the sharp rupee depreciation witnessed over the past few months, most of the industry’s concerns stand addressed to a large extent. However, the industry now faces mounting concerns on the continuance of the export subsidy schemes in India, after being challenged by the US at the World Trade Organisation (WTO), which seems to be constraining the growth momentum of India’s apparel exports.

Going forward, steps taken by the Government to address these concerns, will remain crucial for apparel exporters to capitalise on the revived global apparel trade as well as the continuing loss of market share by China, which opens up a lucrative opportunity for key players such as India, Vietnam and Bangladesh

ICRA notes that Bangladesh and Vietnam have been the key gainers from China’s loss of share of the export market over the past couple of years. Vietnam has been maintaining a healthy growth in its stronghold market of the US, with its position likely to strengthen further if the Comprehensive and Progressive Agreement for Trans-Pacific Partnership and the EU-Vietnam Free Trade Agreement are successfully consummated. Meanwhile, Bangladesh continues to gain share in Europe, even as concerns on withdrawal of its duty-free access to the EU market have surfaced, given the improvement in its economic indicators.

     
 
           
 
   
Rating Updates for the month of August 2018
   
Upcoming Events
September, 2018: Webinar on Indian Port Sector - Sagarmala gathers momentum
September, 2018: Webinar on Indian Apparel Sector: Outlook for India's apparel and fabric segments, as the sector emerges from a challenging environment
ICRA in News
Business Standard: 12thSeptember, 2018: States’ fiscal consolidation is unlikely in FY19
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