The surge in COVID-19 cases in India associated with the Omicron variant may delay the recovery in micro, small and medium enterprises (MSMEs) and microfinance lending, adding to asset-quality risks for Indian non-bank financial institutions (NBFIs), says Fitch Ratings.
The rating agency expects deteriorating asset quality for Indian NBFIs in 2022, stemming primarily from these sectors along with property construction finance.
The financial stability report (FSR) published by the Reserve Bank of India (RBI) in December 2021 noted emerging signs of stress among MSMEs and microfinance. Such borrowers generally run on limited cash buffers and capital, and have suffered disproportionately during the pandemic due to their more vulnerable business franchises.
According to Fitch, MSME business activities picked up during the second half (H2) of FY20-21 but remained below pre-pandemic levels. The surge of Omicron cases in January 2022 may temporarily disrupt the recovery.
"We assume that the scale of disruption associated with the wave will be modest by comparison with India's initial lockdown in 2020 or the Delta variant wave of 2021, and we currently project real gross domestic product (GDP) growth in the year ending March 2022 at 8.4%. Nonetheless, there is likely to be some impact from the Omicron surge as local restrictions are re-introduced. This comes at a time when financial buffers have already been eroded for many small borrowers," it added.
As the government's emergency credit line guarantee scheme (ECLGS), first launched in May 2020, winds down in the coming months, the pressure on MSME would also increase.
Most beneficiaries of the scheme have been micro and small businesses, and new disbursements under it will cease by end-June 2022, Fitch says, adding, "Any non-performing loans (NPL) under the scheme's various iterations will start showing up as the applicable moratoriums on principal repayments expire over the next one to two years."
Recoveries from MSMEs have been sluggish due to slower collateral liquidation during the pandemic, and the rating agency says it expects recoveries of property-backed loans in semi-urban areas to continue to be hampered in 2022 by relatively low liquidity in such real-estate markets.
For microfinance, according to Fitch, further challenges may stem from upcoming elections in five large states, including Uttar Pradesh (UP). It says, "Political pressure can often impede loan-recovery actions around election season, and UP is home to a large rural population and microfinance sector. The state accounted for around 8% of outstanding microfinance loans in India at end-September 2021."
Fitch says it expects stresses in the MSME and microfinance segments to culminate in higher non-performing loans (NPLs), particularly as tightened impairment recognition norms come into effect by March 2022.
"Many lenders with greater exposures in these fields tend to be smaller and reliant on bank funding, and could face funding pressures due to sustained risk-aversion among banks. The severity of further asset-quality deterioration and impairment costs will depend on the pace of economic recovery. We believe the authorities are likely to step in with further forbearance if impairments climb too quickly," it added.
Fitch-rated NBFIs are generally among the more resilient in the sector over 2021, but the rating agency views IIFL Finance Ltd as more vulnerable to potential asset-quality weakening due to its exposure to MSMEs, microfinance and construction finance. However, its provisions and earning buffers provide some headroom to absorb further deterioration at its current rating level, Fitch says.
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