TEXT-Fitch:IFRS to be rating-neutral for large Indian corporates

(The following statement was released by the rating agency)

Oct 19- Fitch Ratings says the introduction of International Financial Reporting Standards (IFRS) in India through the implementation of new Indian Accounting Standards (Ind AS) is expected to improve disclosures and will be rating-neutral for large corporates. Fitch's primary analysis is cash flow-based and the migration to Ind AS and use of fair value accounting would not have any impact on this fundamental analysis. Any changes in credit quality, if any, are likely to emanate from greater disclosures under Ind AS, though the impact, if any, is expected to be minimal and will be restricted to mid-sized listed or unlisted corporates.

Fitch expects that the migration to Ind AS may (in certain cases) necessitate re-classification of cash flow items into different categories; however, the present use of multiple cash flow ratios (rather than a single ratio) by Fitch would mitigate the credit impact. The agency, however, highlights that some of the important provisions in the new accounting standards which credit analysts should take note of include i) proposal to eliminate operating leases ii) accounting for financial instruments iii) consolidation and iv) disclosures and transparency.

From Fitch's perspective, the impact of the first three on ratings is likely to be minimal as operating leases are already capitalised while calculating adjusted ratios (either by using a 7x multiple or taking the net present value where available), and the impact on cash flows through the use of financial instruments during the forecasted period is captured by seeking additional information relating to specific contracts. Fitch captures the consolidation aspect through the use of its "Parent Subsidiary Rating Linkage" criteria, with additional information being sought for entities which presently do not prepare consolidated financials. Availability of consolidated financials for non-listed entities post implementation of Ind AS will not obviate the need for Fitch to seek standalone financials, wherever required, to better understand segment-wise cash flows.

In Fitch's opinion, the key impact of Ind AS standards would be felt through better disclosures and transparency. While Fitch expects the impact to be minimal for large corporates, they could provide early warning signals of potential trouble spots in corporate earnings or cash flows for some of the medium-sized listed corporates or unlisted corporates. Fitch seeks additional information on all these aspects while conducting the rating exercise; however, the extent of disclosures.

Under Ind AS could improve the quality of information and help analysts refine their analytical judgements. Fitch, however, notes that while currently considered unlikely, revelation of material new lease obligations in the form of contingent rentals could also affect a company's credit profile. Under Ind AS, treatment of convertibles (especially foreign currency convertible bonds) will necessitate measurement at fair value and would require splitting into debt and equity components with notional interest being provided in the profit and loss statement on the debt component. From Fitch's perspective, analysts will have to reverse many of these adjustments required by the standard to continue reflecting a cash flow perspective.

Fitch notes that most of the Indian nationalized banks use standalone financials of entities and treat operating leases as an expense in the income statement without adjusting for capitalisation. Hence, the need to restate the operating leases on the balance sheet of the borrower and to use consolidated financials wherever necessitated, could change internal risk assessments of banks for even the larger corporates. The risk is likely to be lower for foreign banks operating in India.

The implementation of Ind AS is applicable for large and/or listed corporates from 1 April 2011; however, the timeline is likely to be extended. Presently, Indian entities prepare accounts as per Indian GAAP which through the implementation of Ind AS will converge with IFRS. The Ind AS takes into account the nuances of the Indian market and hence it has certain "carve outs" compared with IFRS. Small and medium enterprises (SMEs) will be covered by a modified SME version of the IFRS.