Expert Opinion

Published: Dec 29, 2021
Updated: Dec 29, 2021

Covid 2.0 puts paid to recovery

India’s second Covid wave may wreck the expected solid recovery in the economy and credit conditions. The nation’s daily Covid figures continue spiralling, representing practically 50% of the world’s cases and overpowering the country’s health framework. The authorities are forcing more local lockdowns, and this may impede what was resembling a solid bounce-back in corporate profits, liquidity, funding access, government incomes and banking framework profitability. Amid the second Covid wave, Moody’s cut India’s FY22 GDP growth forecast on May 12, 2021 to 9.3% from an earlier forecast of 13.7%. It also ruled out a sovereign rating upgrade, at least for now. Meanwhile, India’s retail inflation as measured by the Consumer Price Index slowed to 4.29% in April 2021 from 5.52% in March 2021, mainly due to easing of food prices as per data on May 12. Industrial output as measured by the Index of Industrial Production (IIP) grew 22.4% in March 2021 compared to 16.7% in the year-ago period.

India’s homegrown banks keep on confronting significant degrees of systemic risk. In the moderate disadvantage situation, the Indian financial framework’s weak loans and advances should stay raised at 11%-12% of gross loans and advances. Credit misfortunes will remain high in FY22 at 2.2% of total loans and advances before recuperating to 1.8% in FY23.

The entities that will be hit most by localised lockdowns are the small and medium-sized enterprises (SMEs), borrowers and low-income households. Most borrowers are cushioned with the availability of additional credit under various restructuring options and plans related to emergency credit guarantees.

ALL SECTORS HIT

Covid has affected various sectors differently. SMEs have been disproportionately hit by the pandemic and are potentially the largest contributors to total non-performing loans (NPLs) for banks in India either this year or the next.

Covid containment measures have resulted in the loss of considerable revenue and profit for airlines, malls, hotels, restaurants, retail trade and many other service sectors. Commercial real estate loans and other high-risk sectors still exhibit vulnerability.

Covid-related provisions have already been put in place by banks in the range of 0.5%-1.5% of loans, which is expected to provide some buffer. Further, to safeguard against NPLs, they have been permitted by the central bank to utilise all other floating and counter-cyclical provisions. Till now, the banking system has shown better performance than expected, and this has provided a headway to our estimates. Unsecured personal loans and credit card debt, which together make up about 10% of the loans in the banking system, along with other retail loans, could also lead to higher NPLs. Commercial vehicle lending and micro-finance lending (MFL) could also pose higher risks, with borrowers being faced with a smaller financial buffer.

GOVT’S HELPING HAND

Such cash-strapped SMEs have been supported for liquidity by the government’s emergency credit guarantee plan for new loans. Still, this will not restore their solvency. The government has widened the scope and extended the credit guarantee plan period to June 2021.

The central bank announced a second restructuring scheme on May 5, whereby banks have been allowed to restructure the debt of stressed-out individuals and MSME borrowers. This aims to tackle difficulties arising from the second Covid wave. However, conditions apply. Such restructurings are capped at Rs 250 million and are available to only such loans that have not undergone any restructuring and loans that were classified as standard as of March 31, 2021. The central bank has also permitted banks to extend repayment moratoriums to a maximum period of two years for those entitled entities who have placed some of their debt in restructuring, and this move is expected to reduce the stress on the balance sheets of the banks and somewhat increase the volume of restructured loans.

In the worst case, the weak loans of our country’s banking system are expected to rise to about 12% of gross loans, and this being so, credit losses are estimated to grow to up to 2.4% of total loans in fiscal 2022, compared with our base case of 2.2%.

In the event of the second Covid wave continuing till June 2021, the subsequent slowdown in economic activity would affect the quality of assets of the banks. This would result in high-strain solvency of some companies, mainly in the earlier-listed stressed sectors.

VICIOUS CYCLE

There are likely to be limited defaults by large corporate and infrastructure companies, even in the worst scenario. If followed by heavy job losses and salary cuts in the formal sector, weak consumption will adversely affect the banking sector’s unsecured personal loans and credit card loans. Additionally, if there is a lower recovery rate of NPLs of the banks, it would increase the weaker loans. However, the worst downside scenario could be the government and the central bank extending support to the borrowers, but with a much reduced fiscal capacity than during the previous Covid wave.

Any extension of the support mechanism by the government and the central bank, including forbearance on NPL recognition, extensions on existing guarantees, or the provision of liquidity support, is likely to support such borrowers who are temporarily affected. However, if the lending to non-viable borrowers is not considered as a part of NPLs, this would only delay recognizing the effect of the same.

(Dr VVLN Sastry is a post doctorate in Economics and a PhD in Law & Public Policy. He is a passionate economist, financial analyst and law expert.)