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Indian central bank takes steps to dampen NPL formation amid COVID-19 resurgence

Surging COVID-19 cases in India may push bad loans in the banking sector higher but latest measures from the country's central bank may soften the impact of the new wave that threatens to disrupt business activity in the country.

With reported new daily cases climbing past 400,000, government data show that more than 3.7 million Indians are currently infected with the virus. However, actual numbers could be much higher. The nation's medical infrastructure is stretched and many state governments have announced restrictions on movement. Analysts and economists expect the virus resurgence to hit the economic recovery that was underway after the South Asian nation witnessed its first recession in 2020. That, in turn, is expected to hurt banks' asset quality.

The Reserve Bank of India, or RBI, on May 5 announced a raft of relief measures for the health industry and borrowers, including special liquidity windows for lenders that fund small businesses. Banks are being allowed to review the working capital limits for small- and medium-scale businesses. The central bank reintroduced a plan to restructure existing loans without a downgrade in the asset classification as part of its prudential framework to resolve stressed assets. The RBI also gave banks permission to use their floating provisions or countercyclical provisioning buffers for nonperforming assets to mitigate the impact of the pandemic.

"The RBI's measures on Wednesday aim to soften the impact of the second wave of the pandemic on individual borrowers and [micro, small and medium enterprises] — the most vulnerable sections of the economy," said Krishnan Sitaraman, senior director for ratings at CRISIL, a unit of S&P Global. "On asset quality, these measures will help limit the rise in [nonperforming loans] this fiscal [year] and credit growth will get support," he said.

Caught off guard

The intensity of the spread of the disease took Indian authorities by surprise. From Prime Minister Narendra Modi claiming that India had become the "pharmacy to the world", supplying drugs and vaccines to nearly 150 countries, India now finds itself short on hospital beds and medical supplies. It has sought international aid in the form of oxygen and antiviral drugs for its hospitals. The world's biggest manufacturer of vaccines has so far been able to fully vaccinate just over 2% of its 1.4 billion population. No nationwide lockdown has been announced yet, though states have been asked to take steps to limit the spread of the disease.

"The second COVID wave does bring along fresh headwinds for the banking sector especially if a strict lockdown is imposed," said Radhika Rao, an economist at DBS Bank. "As it stands, accretion of bad loans to the banking system is estimated to rise by 1.5%-2% by mid of this year."

Many economists have cut their GDP growth forecasts for this year. Oxford Economics downgraded its 2021 GDP growth forecast to 10.2% from 11.8% previously. S&P Global Ratings said May 5 that it cut its forecast of 11% GDP growth this fiscal year ended March 31, 2022. Under a moderate scenario, Ratings expects a GDP hit of about 1.2 percentage points. A severe scenario could shave 2.8 percentage points from the estimated GDP in fiscal year 2022.

"The balance sheet weakness in smaller businesses is likely to contribute to incremental NPLs for Indian banks," said Nikita Anand, an analyst at S&P Global Ratings. "Service sectors such as airlines, hotels, malls, multiplexes, restaurants, and retail have seen a significant loss of revenue and profit on account of COVID-19 containment measures," she said.

Anand estimates the Indian banking system's weak loans are at 11%-12% of gross loans. The "systemic risk facing banks in India is likely to remain high in the wake of the second wave of COVID-19 infections and a high proportion of weak loans," she said.

Supreme Court ruling

A large portion of the expected increase in NPLs among Indian banks was likely due to the Indian Supreme Court's lifting of a ruling that barred banks from classifying any defaults as nonperforming assets. In March, the nation's top court allowed banks to resume classifying bad loans as NPAs, reversing an order from Sept. 30 when it had stopped lenders from declaring any new bad loans in an effort to give borrowers more time to repay.

The central bank said in January that its stress tests indicated that the bad loans of all banks may rise to 13.5% by September from 7.5% in September 2020 under a baseline scenario. If the macroeconomic environment worsens into a severe stress test scenario, the ratio may increase to 14.8%, the RBI said in its biannual Financial Stability Report published Jan. 11.

However, India's banks may now be in a better position to absorb some of the impact of the pandemic. Lenders' balance sheets are stronger now than in the last few years with higher levels of capital and provisioning levels, CRISIL's Sitaraman said. The country's public sector banks grappled with bad loans that predated the pandemic but they have worked on cleaning up their balance sheets in recent years.

Some Indian banks have reported an improvement in their fiscal fourth-quarter net profits. HDFC Bank Ltd., the country's biggest private sector bank by assets, said net profit rose 15.9% year over year to 84.34 billion rupees, with net NPAs increasing to 0.40% from 0.36% in the prior-year period. ICICI Bank Ltd. also reported nearly a fourfold increase in net profit for the fourth quarter as it reported a decrease in its NPA ratio to 1.14% from 1.41% a year ago.

S&P Global Ratings said in an April 28 note that while banks' asset quality remains strained and credit losses will continue to hold back profitability in fiscal 2021-2022, India's speedy economic recovery until March has partially alleviated NPL stress.

As of May 7, US$1 was equivalent to 73.26 Indian rupees.