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Monday, April 28, 2014

IMF warns about the increasing debt of corporate India.

Is there any scientifically proven optimal debt to equity ratio? Well, not really but the number that can come pretty close to it is perhaps 100%. In other words, if past history is anything to go by, the moment debt starts getting higher than the equity base of a firm, investors should start turning cautious. And this is precisely why a news item in a leading daily has us worried. It highlights how about one third of the corporate debt in India is having a debt to equity ratio of more than 3 times! And the agency to flag off this warning signal is none other than the global financing agency, the IMF.

It has further pointed out how about half the corporate debt in India is on the books of companies with return on assets less than 5%. Basically, this does not even cover the interest expenses. Similarly, more than 20% debt is owed by firms with profit to interest expenses ratio being less than one. Clearly, should the economic scenario worsen further, we could well be staring at a fresh round of troubles for the Indian banking sector. For this reason alone, the sector may not be a haven for value investors as it is being made out to be.

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