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Unorthodox approach may hit `AAA' ratings

T.B.Kapali

IT is no surprise if companies such as Larsen & Toubro or HDFC get the highest credit ratings for their on-going debt programmes or for their existing liabilities. At least by conventional yardsticks, one cannot question such companies a nd their debt being rated as the highest quality credits.

A slightly unorthodox approach (unorthodox in the Indian context) though would appear to highlight not necessarily favourable aspects about such companies' liabilities.

The reference here is to the fact that many such companies continue to be anchored to or rather remain prisoners of high cost borrowings on their books; whereas market interest rates have declined substantially over the past 3 or 4 years and particularly in the past year or two. Five-year `AAA' corporate bonds can now be sold for around 11.50 per cent whereas 3 or 4 years back, coupon offers should have been easily 15 or 16 per cent.

Now, it is in respect of such high cost debt - those 15 or 16 per cent liabilities - that the credit rating agencies continue to award the highest ratings. One would think that there is quite a serious anomaly here.

The conventional credit rating approach does not appear to take into account the fact that by being a prisoner of high cost borrowings, a company may well be losing out on business opportunities. Or could be earning (on a net basis) less than what may be possible if its borrowing costs were to move in line with market interest rates. More so, in an environment of intense competition in the markets - both for goods and for financial products.

From a larger perspective, such anomalies in ratings also serve to highlight the absence of interest rate risk management products in the domestic financial markets. Interest rate risk, pure and simple. That is what companies such as HDFC and L&T are car rying on their books. But they continue to be high quality credits.