COVID and Indian Banks: One Step Forward, Two Steps Back
The coronavirus (COVID-19) pandemic may set back the recovery of India's banking sector by years, which could hit credit flows and, ultimately, the economy. Non-performing loans (NPLs) in India will hit a fresh high, raising credit costs, and putting pressure on ratings, says ratings agency Standard & Poor's (S&P).
 
According to a report "COVID And Indian Banks: One Step Forward, Two Steps Back,"  published by S&P Global Ratings, Indian banks' NPL ratio could increase by about 50% in the current fiscal year and it will take 12-18 months to get Indian financial institutions sector recovery back on track, leading us to our recent negative ratings actions on lenders.
 
"In our base case, we expect the NPL to shoot up to 13%-14% of total loans in the fiscal year ending 31 March 2021, compared with an estimated 8.5% in the previous fiscal year," says S&P Global Ratings credit analyst Deepali Seth-Chhabria. "Moreover, the resolution of these bad-debt situations will likely unfold slowly, which means banks may also be saddled with a huge stock of bad loans next year. We assume only about a 100 basis points (bps) improvement in nonperforming loans in fiscal 2022."
 
According to S&P, after years of deterioration, asset quality in the Indian banking system had improved over the past 18 months, helped by higher write-offs, slower accretion of bad loans, and resolution of some big cases under the new bankruptcy law. Nevertheless, it says, Indian banks were still working through a formidable overhang of nonperforming assets when the COVID crisis struck and this largely derailed that rehabilitation process.
 
"We believe that the effect on finance companies will be more pronounced than on banks," said S&P Global Ratings credit analyst Geeta Chugh. "Some finance companies lend to weaker customers and have high reliance on wholesale funding. These companies were already facing a trust deficit since the 2018 default of Infrastructure Leasing & Financial Services (IL&FS). Finance companies also face accentuated liquidity risks due to high proportion of borrowers opting for loan moratorium."
 
S&P says it assume India's GDP will contract 5% in the fiscal year ending 31 March 2021, which will translate into diminished asset quality for Indian financial institutions over the next couple of years.
 
 
The ratings agency says it expects credit growth to remain weak in the current fiscal year. "We estimate low single digit loan growth for the system for the current year, mainly driven by government-guaranteed small businesses loans and the capitalisation of accumulated interest."
 
ON 26 May 2020, the Indian government launched a Rs3 trillion emergency credit scheme for micro, small and midsize enterprises (MSMEs), to help them weather the pandemic. 
 
"Otherwise, lending should remain slow due to tepid demand, and because banks have turned risk averse (despite ample liquidity). Among the risks to our assumptions, the government may push public-sector banks to revive credit growth to support the economy," S&P says.
 
The ratings agency sees slippages to shoot up in banking sector. It says, "In our base case, we estimate the banking sector's bad loan accretion will be 6% of existing loans in the current fiscal year, much higher than other large Asian banking sectors. If Reserve Bank of India (RBI) allows restructuring of loans, it may reduce the level of slippage this fiscal. However, in our view, restructuring may not resolve the problem. It may just defer NPL recognition, as it did a few years ago." 
 
 
At that time, S&P says, following rampant restructuring, the RBI had to come up with an asset quality review and withdrew forbearance on the majority of restructured loans, leading to exceptionally high credit costs.
 
 
"Businesses' operational outages and the recession will have a deeper and longer effect on lenders than we previously assumed. We believe service sectors such as airlines, hotels, malls, multiplexes, restaurants, and retail may see a significant loss of revenue and profits due to the outbreak. In addition, highly leveraged sectors--real estate developers, telecom companies and power firms--may remain a source of increased bad debt," it added. 
 
According to S&P, MSMEs will likely be most vulnerable in this down cycle. Under the government credit guarantee plan, MSMEs with up to Rs250 million of debt can borrow an extra 20%. The government will entirely guarantee the incremental loans. The program's Rs3 trillion size equals about one-fifth of outstanding MSME credit. 
 
"This will provide some reprieve to the MSMEs that were going through a stressful period after twin effect of demonetisation (where the government in 2016 ruled certain high denomination notes as invalid, creating cash shortages) and the operational challenges of handling a new goods and services tax, rolled out in 2017," it added.
 
The rise in bad loans should lead to heightened credit costs for lenders, the ratings agency says, adding the credit costs will likely increase again in the current fiscal year and surpass the highs seen in fiscal 2018.
 
It says, "We anticipate credit costs will rise to about 3.7% of average loans in fiscal 2021. This cost should drop to 2% in fiscal year 2022, but this would still be above the 15-year average of 1.5%."
 
Talking about recapitalisation of banks, the ratings agency says, most public-sector banks (PSBs)  improved their capitalization last year, which should provide some support. The common equity Tier-1 ratio of PSBs was 10.1% as of 31 December 2019, higher than the regulatory requirement of 8% (including a capital conservation buffer). Similarly, the Tier-1 ratio was 11.1%, higher than the regulatory requirement of 7%.
 
In its base case, S&P says, government-owned banks as a whole should be able to absorb the estimated credit losses without breaching the regulatory minimum, but these banks need capital to grow. "In our base case, where we have factored in 4%-5% credit growth for government-owned banks in the current fiscal year, and we estimate that the government-owned banks need about Rs350 billion to Rs400 billion of capital this year. That is less than what the government pumped into the lenders in the recent past. The requirement may vary from bank to bank, depending on the growth and level of provisioning. In our view, the government will likely infuse capital into these banks, if and when required, even though they haven't provided for any capital infusion in the current year's budget."
 
"On the other hand, the private-sector banks that we rate are well capitalised and should be able to absorb the increase in provisioning. Moreover, these banks have more capacity to raise external capital than public-sector banks, if required. For example, ICICI Bank has recently divested its stakes in some of its insurance subsidiaries. Moreover, we expect the bank will structurally improve its capital position and balance sheet over the next 12-18 months, which will offset the impact of deteriorating operating conditions and may support ratings at the current level," the ratings agency added.
 
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    India's GDP to Contract by 5.3% in FY21, Bounce Back in FY22: Ind-Ra
    India's gross domestic product (GDP) is likely to contract 5.3% in FY21, the lowest GDP growth in the country history since FY51 and sixth instance of economic contraction, others being in FY58, FY66, FY67, FY73 and FY80, says India Ratings and Research (Ind-Ra).
     
    The previous low of Indian GDP was negative 5.2% in FY80. The disorder caused by the COVID-19 pandemic unfolded with such a speed and scale that the disruption in production, breakdown of supply chains and trade channels and total wash out of activities in aviation (some activities have started now), tourism, hotels and hospitality sectors will not allow the economic activity to return to normalcy throughout FY21. 
     
    As a result, Ind-Ra says, besides contracting for the whole year, GDP will contract in each quarter in FY21. However, the agency says it believes the GDP growth would bounce back in the range of 5%-6% in FY22, aided by the base effect and return of gradual normalcy in the domestic as well as global economy.
     
     
    The government of India announced an economic package of Rs20.97 trillion (10% of GDP) on 12 May 2020 to mitigate the adverse impact of COVID-19 and related lockdown. 
     
    However, Ind-Ra says as per its calculations, excluding the monetary measures and existing proposals in the union budget, the direct fiscal impact is only Rs2,145 billion (1.1% of GDP). 
     
    It says, "The credit and liquidity enhancing measures announced in the economic package in combination with some of the earlier steps announced by the Reserve Bank of India (RBI) will certainly address the supply-side issues of the economy. The Indian economy even before the COVID-19 related lockdown was suffering on the demand side, as all the demand drivers, except government final consumption expenditure (GFCE), namely private final consumption expenditure (PFCE), gross fixed capital formation (GFCF) and net exports were floundering." 
     
    "The lockdown and its impact on economy and livelihoods only aggravated the sagging consumption demand. We believe the government is aware of it; but, the near absence of demand-side measures in the economic package indicates the hard budget constraint facing the government," the ratings agency added.
     
    Ind-Ra says it expects PFCE to contract 5.1% in FY21 to reach a level lower than in FY19. It says, "Even GFCF will contract 17.6% in FY21 and the investment revival will now be pushed beyond FY22 due to a combination of factors such as excess capacity, weak domestic and global demand, stretched or leveraged balance sheet of Indian corporates and, budget constraints leading to reduced government capex." 
     
    As per the ratings agency, external environment continues to be challenging due to COVID 19 related restrictions coupled with trade friction and protectionist policy pursued by many developed economies. 
     
    Ind-Ra says it expects merchandise exports to decline 9.4% in FY21 compared with negative 4.9% in FY20, as all major export commodities would clock negative growth. Merchandise imports are expected to decline 17.4% in FY21 as against negative 8.9% in FY20. The import of coal; coke and briquettes; crude oil and gold and transport goods may decline significantly in FY21. As a result, the trade deficit is estimated to decline to a four-year low of $97.7 billion (3.9% of GDP) and current account deficit to $3.3 billion (0.1% of GDP) in FY21. However, 1QFY21 may see a current account surplus, it added. 
     
    From the supply side, agriculture is the only bright spot, Ind-Ra says, adding, "Agricultural gross value added (GVA) is expected to grow 3.5% yoy in FY21. The India Meteorological Department (IMD) in its second stage forecast for Southwest monsoon rainfall has predicted the monsoon rainfall to be 102% of long period average (1961-2010) in 2020. The industry and services GVA is expected to contract 15.8% and 2.2%, respectively, in FY21." 
     
    Ind-Ra says it expects the retail and wholesale inflation to come in at 3.6% and 1.2%, respectively, in FY21. "Inflation in FY21 will be largely governed by monsoon rainfall, global commodity prices especially crude oil and monetary and fiscal policy pursued by the Reserve Bank of India (RBI) and government to mitigate COVID-19," it added.
     
    The RBI in addition to pursuing a fairly accommodative monetary policy has been quite swift and proactive both before and after the COVID-19 lockdown to ensure smooth functioning of the financial market. Yet, Ind-Ra says, risk aversion in the financial market has remained elevated and the rate spread between the policy rate and instruments of various tenors, instead of coming down, has widened. 
     
    The spread between 10-year G-sec and policy rate averaged 186 basis points (bp) in June 2020 (up to 15 June). Ind-Ra therefore expects the FYE21 interest rate on 10-year G-sec to be in the range of 6.2%-6.3%. 
     
    "Fiscal deficit of the central government in FY21 is expected to more than double (7.6% of GDP) the budgeted amount (3.5% of GDP). The majority of the fiscal slippage will be from the revenue side," the ratings agency concludes.
     
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    Moody's cut India's GDP forecast to (-)3.1% for 2020
    Global ratings agency Moody's Investor Services on Monday reduced its calender year 2020 economic growth forecast for India to (-)3.1 per cent, from its earlier projection of (+)0.2 per cent.
     
    It said that effects of lockdowns on Q2 activity will be larger than previously thought.
     
    "Incoming data show the extent of coronavirus-related disruption in Q1 and Q2," a report by Moody's Investor Services said.
     
    "As a result, we have revised down our 2020 growth forecasts for Germany (Aaa stable), France (Aa2 stable), Italy (Baa3 stable), the UK (Aa2 negative), Canada (Aaa stable), Brazil (Ba2 stable), India (Baa3 negative), Indonesia (Baa2 stable), Saudi Arabia (A1 negative) and Argentina (Ca negative)."
     
    The ratings agency predicted a rise in real GDP growth to 6.9 per cent for 2021.
     
    On June 1, the credit ratings agency downgraded India's sovereign ratings as it saw challenges being piled upon the country's policymaking institutions to mitigate the risks of a sustained period of relatively low growth.
     
    Besides, Moody's said the Covid-19 pandemic amplified vulnerabilities in India's credit profile such as slower growth relative to the country's potential, rising debt and further weakening of debt affordability and persistent stress in parts of the financial system.
     
    Consequently, Moody's downgraded India's foreign-currency and local-currency long-term issuer ratings to Baa3 from Baa2.
     
    It also downgraded India's local-currency senior unsecured rating to Baa3 from Baa2, and its short-term local-currency rating to P-3 from P-2.
     
    Furthermore, it kept the outlook as negative. Currently, the sovereign rating assigned to India is Baa3 with a negative outlook.
     
    Disclaimer: Information, facts or opinions expressed in this news article are presented as sourced from IANS and do not reflect views of Moneylife and hence Moneylife is not responsible or liable for the same. As a source and news provider, IANS is responsible for accuracy, completeness, suitability and validity of any information in this article.
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