Troubles for Indian banks are set to worsen over the next year amid slow economic growth, the ratings firm Standard & Poor's warned yesterday, ahead of a crucial federal budget on Thursday.
"Reduced economic activity, high inflation, and elevated interest rates have been the bugbears of Indian banks for the past couple of years," said Geeta Chugh, S&P's director and analytical manager for financial institutions ratings in emerging Asia. "During this period, corporate performance suffered and banks' non-performing assets soared and earnings were hit.
"We expect the asset quality of Indian banks to remain weak over the next 12 months," said Ms Chugh. "We expect nonperforming assets to surge and banks' return on assets to remain depressed, at about 0.9 per cent [in the next financial year]."
The warning comes as India is easing the process for new private banks to set up in the country. The Reserve Bank of India (RBI) on Friday published fresh guidelines that pave the way for the country's corporate houses to set up banks. The central bank has set a deadline of July 1 for applications for the licences.
India this month lowered its expectations for the economy, projecting that growth would hit a decade low of 5 per cent in the year ending next month.
Economic growth slowed to 5.3 per cent in the quarter between July and September. The RBI last month cut its policy lending rate by a quarter of a percentage point - the first since April and the second for four years. The country is grappling with large budget and current account deficits, a weak rupee and high inflation, along with wider problems facing the global economy.
All this has contributed to an increase in the bad debt held by Indian banks, particularly the public sector institutions, as they have been affected by stalled infrastructure projects and weaknesses in some areas of the corporate sector.
However, the yield on India's bonds due 2022 held near a 31-month low amid optimism the government will announce plans to rein in the budget deficit this week.
The finance minister Palaniappan Chidambaram, who will present his annual budget to parliament on Thursday, is expected to present austerity measures.
Pressure on banks has also built up thanks to the slow pace of policy reforms, but the situation was likely to eventually improve in India as measures announced by the government filtered through, according to S&P. Woes for India's banks are only likely to ease in the next financial year, starting in April 2014, according to S&P.
"We expect that the pace of the deterioration will decline as the economic and corporate sector performance bottoms out," said Ms Chugh. "We expect that the Indian economy will start recovering from the next fiscal [year]."
S&P expects an improvement in private consumption and lower interest rates, while welfare spending by the government could also help to boost economic activity, the impact of which would trickle through to the banking sector.
Others have also sounded notes of caution on the banking industry. Moody's Investors Service last month said that its outlook for the sector remained negative for as long as the next 18 months.
Uday Kotak, the managing director of Kotak Mahindra Bank, recently said that bad debts posed the biggest threats to banks.
Some one million public sector bank employees staged a two-day strike last week as they voiced issues including concerns about India's banking sector being opened up to greater control by private and foreign companies.
S&P said it maintained its negative outlook on all the banks it rated in the country.
"This reflects the negative outlook on the sovereign rating," S&P said, adding that it "does not rate Indian banks above the sovereign rating because of the direct and indirect influence the sovereign in distress would have on a bank's operations, including its ability to service foreign currency obligations".
S&P's warning last year that India was at risk of having its sovereign rating downgraded to junk status triggered widespread concerns surrounding the economy.
* with agencies