Muted external remittances growth is more of a structural issue than transitory and it would further weaken aggregate consumption demand, though the impact will be restricted to a few states, given their skewed shares in foreign remittances, says India Ratings and Research (Ind-Ra).
Historically, India has remained the largest receiver of remittances in the world. However, the share of remittances as a percentage of gross disposable income receded to 2.5% in FY18-19 from 3.5% in FY09-10. The growth rate in four different periods shown below suggests that the flows had started to moderate even before the outbreak of COVID-19, the ratings agency says.
Various empirical studies have suggested that remittances are an important driver of a smooth consumption cycle. Thus, countries with large dependence on remittances act as a counter cyclical buffer against a fall in domestic output. Additionally, remittances have a positive impact on household savings and act as a consumption booster. Therefore, the ratings agency feels that the pandemic-led slowdown in consumption is likely to get exacerbated by the muted remittance flows.
The falling oil prices and recessionary pressures that exacerbated due to the COVID-19 outbreak have led to job losses and salary cuts globally, it added.
According to World Bank, Indian diaspora constitutes close to 16 million people around the world, of this, 55% are situated in Gulf Cooperation Council. Furthermore, remittances from the region constitute 54% of the total remittances to India.
According to the Bank, global remittances are projected to decline by 20% yoy in 2020 due to the economic crisis induced by COVID-19 pandemic.
Interestingly, the NRI (non-resident Indian) accounts excluding FCNR (foreign currency non-resident) account have seen positive growth, owing to higher savings by NRIs due to COVID-19 related uncertainty.
On the macro front, a considerable flow of remittances directly impacts aggregate demand and thus the banking sector deposits. Meanwhile, banks with a higher NRI deposit ratio in the total portfolio will be better able to hedge their risk than others, as the overall banking sector deposits are stable along with muted credit offtake.
According to Ind-Ra, FCNR has witnessed a year-on-year (y-o-y) fall in deposits, whereas overall NRI accounts have reported an increase. However, in Ind-Ra’s rated portfolio, The Federal Bank Ltd and The South Indian Bank Ltd have reported subdued growth in NRI deposits.
The ratings agency opines that the key risk for banks will only emerge if the fall in deposits will continue amid an increase in withdrawals due to the factors induced by the pandemic. At the same time, it says, banks will be able to manage this risk better with the help of improved domestic deposits amid muted credit growth.
Ind-Ra says it believes that in spite of the muted external remittances, the impact would largely be restricted to the aggregate consumption level in the first order and the buoyancy in foreign capital flows would compensate the requirement of capital.
According to the ratings agency, there are multiple dynamics of sending remittances, starting from the pattern of migration, taxation, cost of remittances to comparative return between host and home countries and all these factors are structural enablers for remittances, whereas income generation is the largest driver.
"Remittances are not closely linked to capital flows because it is a transfer of income to home destination. Therefore, the motivation is less of speculation, and remittances have remained more of a stable source. The cyclicity of remittances have largely been dependant on the country of origination of remittances. In the case of India, Gulf countries are the largest source of remittances, thus oil price has been recognised as the major driver for quantum of flows. Additionally, geopolitical conditions play a critical role," Ind-Ra added.
India receives its major remittances from the Gulf Cooperation Council (GCC) nations which have stagnated since 2015 due to volatile oil prices in global markets. The economic growth of the region depends heavily on oil prices. The remittances from the region will be further pressured due to COVID-19 related factors coupled with falling oil prices, Ind-Ra says.
The NRIs, besides sending money back home, also avail bank facilities to park their funds as deposits in Indian banks to avail the benefit of high interest rates. Owing to the deteriorating macro variables of host countries, there has been a slight fall in the overall NRI deposits. The ratings agency opines that FCNR deposits will continue to witness a muted flow in FY20-21.
Ind-Ra says it has assessed NRI deposits in its rated portfolio to check the vulnerability of its rated issuers. The NRE (non-resident external) account of Federal Bank constitutes 40% of its total deposits whereas 30% of the total deposits of South Indian Bank are dependent upon NRI accounts. Both the banks have reported a rise in their NRE accounts and NRI accounts, respectively.
"The major cause behind the heightened deposits, despite falling remittances, is more savings amid the COVID-19 crisis, along with favourable interest rates. The banks have proved a stable deposit ratio like during the previous crisis such as the 2008-2009 global financial crisis. The banks will be able to manage this risk with stable deposit growth coupled with muted credit offtake. However, in case the inflows continue to slacken, increased withdrawals will heighten risks," the ratings agency concludes.