Fitch: Falling Rupee Will Add to Indian Banks’ Woes

The sharp depreciation of the Indian rupee (INR) will add to credit pressures on India’s banks, says Fitch Ratings.

The credit ratings agency (CRA) adds that the current economic slowdown is also likely to be deeper and longer than previously anticipated, adding to the pressures already faced by the local banking sector.

The 21% depreciation of the INR since 1 April is likely to pressurise the financial performance of the Indian corporations with unhedged foreign-currency borrowing. Fitch suggests. As a result, Indian banks’ asset quality could remain under prolonged pressure. Moreover, the sharp weakening of the currency, if not swiftly reversed, will delay any chances of recovery in domestic demand.

Recent monetary measures to support the currency have raised the likelihood of a further slowdown within the fiscal year ending March 2014 (FY14). These policy measures, which have sharply raised short-term rates, follow a sub-5% year-on-year gross domestic product (GDP) growth rate over the past few quarters. These developments belie Fitch’s earlier expectation of a modest pick-up in India’s economic growth. They will also subdue any improvement in the growth rate of loan books.

One likely result is that banks’ earnings profiles will encounter more pressure than previously anticipated. This is because of weaker margins resulting from higher funding costs, and a lower ability to pass on costs to the customer due to soft demand and slowing loan growth.

Most recent Reserve Bank of India (RBI) data on stressed assets (non-performing loans (NPLs) and restructured) for the system was 10% of total loans. But this was before the onset of the most recent fall in the rupee. Fitch’s original estimates of stressed assets in the system peaking in FY14 would need to be revised, and is now likely to peak only in FY15. A more prolonged deterioration in asset quality will also raise provisioning requirements and weigh on banks’ earnings profiles.

No bank is likely to be unscathed by recent events. But public sector banks remain under relatively greater pressure. This is because their (standalone) stress-absorption capacity is comparatively lower than their private-sector peers, adding further downward pressure on their viability ratings. However, as most public-sector banks’ Indian Depositary Receipts (IDRs) factor in support from the sovereign, the outlook at that level remains stable – in line with that of the sovereign.

Overall, heightened credit pressures would add to concerns about capital adequacy for certain parts of the system. That said, recent statements by the authorities which recognise the need to maintain the capital positions of public sector banks should prove supportive.

Fitch concludes that there are two potential silver linings, however, amid the rising credit pressure. First, the normal monsoons this year could put a floor beneath slowing domestic demand, especially in the agricultural sector. Second, greater recourse to bank borrowing by Indian corporates which face sharply heightened pressure in the local bond market, could also limit the risk of a slowdown in loan demand greater than what might have been feared.

In a separate report, Fitch said that INR depreciation has varying levels of implications for rated energy and utilities companies in India, but their ratings are not immediately affected. The risks to standalone financial profiles are highest for state-controlled petroleum marketing companies among the Indian energy sector issuers currently rated by the CRA.

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