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ICRA expects the current account deficit (CAD) at around 2.6% of GDP for FY2019, a moderation from the peak deficit of 3%, likely to be recorded in Q2 FY2019. The steep correction in crude prices has eased concerns regarding the size of the deficit to some extent. The bulk of the increase in merchandise trade deficit to US$49 billion in Q2 FY2019 has been driven by higher imports of crude and gold, the recent correction in crude, along with the expected seasonal uptrend in exports, should moderate the CAD in H2 FY2019, compared to H1 FY2019. Overall ICRA expects merchandise exports to rise by 9-10% in FY2019, whereas merchandise imports should increase by 12-13%, resulting in a trade deficit of US @187-192 billion for the full year. The CAD is, therefore, expected in the region of US$68-73 billion.

We also examine how the prevailing liquidity scenario and the accompanying challenges would impact retail NBFCs. Constrained funds availability, higher incremental cost of funds and moderation in portfolio growth, leading to low earnings, are key concerns the NBFCs are grappling with. Also, there are concerns on the asset quality in case of select segments like small business credit and loan against property should the incremental funding to these segments remain subdued. Overall, we expect retail NBFC credit growth to drop to 16-18% during FY2019 as against the 25% growth reported in H1 FY2019. On the positive side, the asset liability profile is improving, given the slowdown in disbursements and additional liquidity in the form of cash and investments that most NBFCs are keeping.

As in the case of NBFCs, revenue growth and profitability of the broking industry too is expected to moderate in the current fiscal, given the significant underperformance in the mid and small-cap segments, which affected retail participation, especially on the cash segment, and a further correction in the broking yields. The volatility in the markets and corrections in valuations has also affected the fund-raising plans by corporates, resulting in a significant slowdown in equity mobilisation through public issuances as well.

We also look at the domestic auto components industry, which is likely to grow at around 15% during FY2019, supported by the growing OEM volumes, improved realisation and content per vehicle. However, growth is expected to moderate next year, given the slowdown in the Passenger Vehicle segment. While operating margins are expected to remain range-bound, we expect some consolidation in the industry as rapidly evolving technology and shorter vehicle shelf-life creates its own challenges.

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
   
  India’s current account deficit likely to rise to 3.0% of GDP in Q2 FY2019
 

kinjal ICRA expects the current account deficit to widen sharply to US$19-21 billion or 3.0% of GDP in Q2 FY2019, from the modest US$7 billion in Q2 FY2018, led by higher crude oil prices and gold imports. However, the subsequent correction in crude oil prices has eased concerns regarding the size of the current account deficit in H2 FY2019. ICRA forecasts India’s current account deficit at US$68-73 billion or 2.6% of GDP for FY2019.

The bulk of the increase in the merchandise trade deficit to US$49 billion in Q2 FY2019 from US$34 billion in Q2 FY2018, was driven by higher imports of petroleum, crude and products, and gold. Benefitting from a weaker INR, the surplus of services trade improved to around US$19 billion in Q2 FY2019 from US$16 billion in Q2 FY2018, which should help absorb a portion of the rise in the merchandise trade deficit between those two quarters. Nevertheless, ICRA expects the current account deficit to triple to US$19-21 billion or a high 3.0% of GDP in Q2 FY2019.”

Following the YoY surge in crude oil prices, India’s net import bill related to petroleum, crude and products increased by a sharp 60% to US$23 billion in Q2 FY2019 from US$14 billion in Q2 FY2018. Additionally, gold imports rose by 61% to US$9 billion in Q2 FY2019 from US$6 billion in Q2 FY2018, with the fall in gold prices in US dollar terms boosting demand and prompting restocking prior to the onset of the festive season. These two item groups account for around 80% of the rise in India’s merchandise trade deficit in Q2 FY2019, relative to the year-ago quarter.

“The recent correction in crude oil prices has doused concerns regarding the size of India’s current account deficit in H2 FY2019. Moreover, a seasonal uptrend in exports should help moderate the current account deficit in H2 FY2019 relative to H1 FY2019. Nevertheless, the current account deficit is forecast by ICRA to widen to ~US$68-73 billion (2.6% of GDP) in FY2019 from US$48.7 billion in FY2018 (1.9% of GDP), if the price of the Indian basket of crude oil averages at US$72/barrel in FY2019

ICRA expects merchandise exports to rise by ~9-10% in FY2019, led by a ~26% jump in oil exports and a modest ~7-8% growth in non-oil exports, driven by sectors such as engineering goods and organic and inorganic chemicals. Moreover, ICRA expects merchandise imports to increase by ~12-13% in FY2019 as a whole, boosted by higher commodity prices, fuel and coal imports, and healthy demand, even though gold imports may remain steady around year-ago levels. Net oil imports are estimated by ICRA to rise to ~US$97-100 billion in FY2019 from ~US$70 billion in FY2018. Assuming that the price of the Indian basket of crude oil averages US$72/barrel in FY2019, ICRA expects the merchandise trade deficit to widen to ~US$187-192 billion in FY2019 from US$160 billion in FY2018.

Notwithstanding an expected improvement in the services trade surplus and remittances benefitting from the depreciation in the INR, the current account deficit is forecast by ICRA to widen for the second year in a row to ~US$68-73 billion in FY2019 from the low US$14.4 billion in FY2017 and moderate US$48.7 billion in FY2018.

  Liquidity concerns to have multifaceted impact on near-term Retail-NBFC performance
 

The prevailing liquidity scenario is expected to impact NBFCs in multiple ways as they are faced with constrained fund availability since September 2018. While the incremental cost of funds has increased by about 100-125 bps since H1FY2019, which would have an impact on their earnings profile, the expected moderation in portfolio growth could further accentuate it. Also, asset quality, especially for some select asset segments namely small business credit, loan against property etc, could weaken, in case incremental funding to these segments remain subdued for a prolonged period. Considering the target borrower segments of NBFCs, namely self-employed customers, increase in the borrowing cost would also impact their debt servicing capability, if the operating or demand environment weakens.

Retail-NBFC credit, which stood at Rs.8.3 trillion as on September 30, 2018, to expand at a slower pace of 16-18% during FY2019, vis a vis the 25% year-on-year growth reported in H1FY2019. Retail-NBFC credit growth during H1FY2019 was highest in the last 5-6 years. Among the key target segments, some would witness headwinds namely vehicle finance because of competitive pressures from banks while small enterprises and business credit would get hit as re-finance risk has increased for this segment post the liquidity squeeze. These segments together account for 70-75% of the Retail-NBFC credit.

90+ days past due (dpd, excluding microfinance) for Retail-NBFCs declined to about 4.2% in September 2018 from 4.4-4.5% in March 2018. Asset quality improvement was on the back of a relatively stable or improvement witnessed in some key asset classes, namely commercial vehicle (CV), small enterprise credit (including loan against property), tractor, gold loans and construction equipment (CE). The improvement could also be partly attributed to the sharp revival in portfolio growth observed since September 2017 as demonetisation and GST-related headwinds waned. Going forward however asset quality pressures to re-emerge due to the weakening in operating and demand environment for some asset segments, increase in systemic rates and tightening in market liquidity.

The asset liability maturity profile for Retail-NBFCs improved in September 2018 as compared to March 2018 as entities slowed-down disbursements and augmented on-book liquidity in the form of cash and liquidity investments. The cash and liquid investments as proportion of asset under management improved to over 4.5% in September 2018 from about 2.3% in March 2018.

The cumulative impact of the increase in the cost of funds, strain on business yields on the back of the increase in liquid investments, competitive pressures and expected weakening in operating efficiencies because of lower growth would impact operating profitability of Retail-NBFCs by about 30-50 bps in the current fiscal. Further, the envisaged re-surfacing of asset quality concerns could result in increased credit costs; thus, Retail NBFCs are expected to register return on average managed assets (RoMA) of 1.6-1.8% for FY2019 vis a vis 2.1% (on 12-month trailing basis) in September 2018.

  Revenue growth and profitability of the Indian Brokerage Industry to taper amid market volatility and cautious investor sentiment
 

The Indian broking industry is estimated to post a moderate growth of 5-10% in FY2019 with an estimated revenue projected at Rs. 19,500-20,000 crore. This is on the back of a strong FY2018 with industry turnover of Rs. 18,000-19,000 crore and Y-o-Y growth of over 30%. While the volatility in the markets is expected to encourage trading turnover, the recent corrections in valuations, coupled with the cautious investor stance is expected to dampen the industry’s revenue growth prospects. The broking yields are expected to contract further, given the competitive pressures and the increase in low-yielding derivatives and the non-delivery segment. This, in turn, is expected to result in moderation of profitability from core broking operations in the current fiscal after a year of supernormal profits. Services like margin funding and distribution of financial services could help support the income profile of full-service brokerage houses given the price-based competition from discount brokerage houses.

The markets reported a resurgence in the current fiscal after a slide in February and March 2018, before witnessing a correction from September 2018. Concerns like rising interest rates, systemic liquidity tightening, heightened concerns on the credit quality of non-banking financial companies (NBFCs) and weak investor sentiment further impacted the markets. On an aggregate basis, the equity markets reported a turnover of Rs. 1,191 lakh crore in H1 FY2019, registering a growth of 55% over Rs. 770 lakh crore in the corresponding period in the previous fiscal. The average daily turnover (ADTO) increased to Rs. 9.53 lakh crore from Rs. 6.21 lakh crore during the same period and was Rs. 7.04 lakh crore in FY2018. The recovery in the first half of this fiscal, however, was largely limited to the large-cap segment. While the flagship indices of the two exchanges touched an all-time high in August 2018, rising to about 5% over the earlier high achieved in January 2018, the mid and small-cap indices on the two exchanges trailed ~5-20% behind the peak level seen in January. The underperformance of mid and small-cap securities had a bearing on retail investor participation, particularly in the cash segment, with the investors yet to recoup their losses. The decline in delivery volumes in the cash segment also points towards the growing shift towards trading as opposed to investment-oriented transactions.

The domestic capital markets are expected to remain rangebound over the near term with a prolonged period of volatility given the weakening of investor sentiment and challenging domestic and global cues. Going forward, the foreign portfolio investment (FPI) flows are expected to remain muted considering the weak macro-economic outlook. Other factors like corporate earnings, state election outcome, result of the resolution of non-performing assets (NPAs) and its impact on the health of the banking sector would be other determinants for FPI flows. The domestic institutional investor (DII) segment, a net buyer of equities since FY2016, is expected to remain steady over the near term and would provide support to the domestic capital markets. While the FPI segment will remain a key market participant, a growing DII segment is a positive development for Indian capital markets, providing them with much-needed resilience. Going forward, a meaningful revival in corporate earnings and abatement of liquidity and capital availability issues would be a key for further fillip to the capital markets and for boosting FPI equity inflows. Notwithstanding these, the near-term outlook for the domestic broking industry is stable.

     
  Domestic auto components industry to grow ~15% in FY2019
 

The Indian auto components industry is expected to grow at around 15% during FY2019 despite the recent demand slowdown witnessed in the key user segment, the automotive industry. As per an ICRA research report, demand growth had been strong till November’18. The uptrend began post the pre-GST inventory destocking leading to a sharp contraction in sales volumes during April-July 2017 and the base effect translating into sharp volume growth across several segments of Original Equipment manufacturers (OEM) and replacement demand in 8M FY2018. However, weakness have crept in during Q3FY2019, resulting in a sharp decline in all the segments except tractors. The rating agency expects automobile volumes to grow by ~8-9% during FY2019, as against 14.8% growth during FY2018 and 5.4% during FY2017. Weighted-average demand for auto components from OEMs is expected to grow by 10-11% in FY2019 (as against 9.5% in FY2018) supported by strong CV volumes.

The aftermarket sales were impacted in FY2018 by GST-related inventory destocking in Q1 FY2018 and initial implementation related uncertainties in Q2 FY2018. However, demand picked up in August-September 2018, with a sharp revival from Q4 FY2018. We expect the aftermarket segment to have grown by 20%+ in Q2 FY2019 and H1 FY2019 on Y-o-Y basis (excluding tyres and batteries), with part-growth attributable to the low base effect in H1 FY2018.

As for export sales, trade disputes, punitive tariffs, higher fuel prices and rising interest costs is expected to play spoilsport in light vehicle sales in the USA (the main market for auto components industry other than Europe) over the next 12-18 months. The US Class 8 truck retail sales which has been exhibiting strong growth of 25%+ Y-o-Y over the last four quarters, is expected to be muted in CY2019, as considerable inventory build-up has happened in CY2018.

Prices of all key commodities, except rubber, have witnessed a Y-o-Y increase in Q2/H1 FY2019. The upswing in commodity prices over the last few quarters is reflected in ICRA’s input car cost index breaching the FY2015 peak during FY2018 and inching up further by ~9-10% in H1 FY2019. Nevertheless, the OEM price pass-through clause which several tier-1 ancillaries enjoy, and operating leverage benefits from higher volumes have mitigated the impact on operating margins to a large extent.

ICRA’s sample set of auto component companies witnessed strong top line growth of 20.0% during Q2 FY2019, in line with the Y-o-Y growth over the last three quarters. For H1 FY2019, the industry witnessed a topline growth of 21.9% Y-o-Y. The domestic tyre industry benefited from strong growth in both the OEM and replacement segments, growing by 16.4% in Q2 FY2019. While there were some headwinds like Kerala floods, tightened financing and insurance related regulatory changes impacting two-wheeler (2W) demand, and rising fuel/interest costs, the sales growth across most segments was robust, leading to healthy OE tyre demand growth. Replacement tyre demand also recovered sharply supported by pickup in infrastructure activity and healthy consumption-driven demand. For H1 FY2019, the OPM of ICRA’s auto component sample has increased by 80 bps Y-o-Y to 13.8%, predominantly aided by margin improvement in tyre companies (which had a dull Q1 FY2018 due to high rubber prices and GST implementation). Margins of tyre companies rose 320 bps Y-o-Y to 12.8% in H1 FY2019, while EBITDA margin of non-tyre players dropped marginally by 10 bps Y-o-Y to 14.2%.

Overall, about 70% of the companies in ICRA’s auto component sample have witnessed decline in operating margins in Q2 FY2019, largely because of inadequate/delayed compensations for currency/commodity price increases, and despite operating leverage benefits from healthy revenue growth. With decline in crude prices over the last two months, drop in prices of commodities like steel, copper and aluminium, and some realization benefits from earlier negotiations, operating margins are likely to improve in H2FY2019 and be in the 13.5-14.5% range in FY2019.

Strong demand over the last 2-3 years has supported higher systemic capacity utilisation for the industry (most players operating at 70%+ capacity utilisation) which along with favourable demand prospects over the medium term has triggered capacity expansion announcements by several players. The capex and investments are likely to sustain at 7-9% of operating income for auto ancillaries (ex. tyres) over the next two fiscals and will subsequently taper down once new capacities become operational.

ICRA has revised the revenue growth outlook from 12-13% to 15-16% for FY2019e, supported by healthy volume growth in 2W, CV and tractor segment as well as 4%-5% impact of commodity prices on realization. While revenue growth rate is expected to slow down from 20%+ witnessed during H1 FY2019e, the overall growth rate is still expected to remain in the double digit. However, sharp depreciation in the INR will weigh on imports which along with commodity prices will pressure margins. The operating margin of auto ancillaries are estimated to remain range bound in 13.5%-14.5% range over the medium term, despite some pressure in the current fiscal (FY2019e).

     
 
           
 
   
Rating Updates for the month of December 2018
   
Upcoming Events
January, 2019: Webinar on Indian Cotton Spinning Industry
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