Ratings agency bashing is a favourite pastime for many of us, which is why when Moody\u2019s Investors Service last week downgraded the outlook for India\u2019s banking system to negative from stable, citing concerns that global economic turmoil and a domestic slowdown may lead to loan defaults and curb profitability, there was a chorus of protests. A negative outlook is characterized by volatility and uncertain conditions. Senior bankers, economists and the government uniformly derided Moody\u2019s action, dubbing it unwarranted and something that defied logic.
\nThere was a collective sigh of relief when the next day another global rater, Standard and Poor\u2019s, lifted the risk profile of the Indian banking industry by one notch, from 6 to 5, saying banking regulations in India are in line with international standards, and the banking regulator, the Reserve Bank of India (RBI), has a moderately successful track record. The agency\u2019s country risk assessment is scored on a scale of 1 to 10, with 1 representing a lowest-risk banking system.<\/p>\n
Apart from rising loan defaults, Moody\u2019s is concerned about Indian banks\u2019 ability to raise enough capital to support credit growth, and the rise in the borrowing programme of the Indian government, which could drain funds away from the private credit market. The agency sees downward pressure on the banking industry\u2019s ratings, although it has assigned a stable outlook to 14 of the 15 Indian banks it rates. Collectively, this pack accounts for two-thirds of the industry.
\nEarlier, in May 2009, in the wake of the global credit crisis following the collapse of US investment bank Lehman Brothers, Moody\u2019s had threatened to downgrade 13 Indian banks on concerns about the government\u2019s ability to support the banking system through capital infusion when the fiscal deficit is high. It did not take action then, but last month it downgraded India\u2019s largest lender, State Bank of India, for its rising bad assets and the lack of enough capital that can curb its ability to lend.
\nIndeed, the concerns of Moody\u2019s are somewhat exaggerated as most Indian banks are adequately capitalized and their level of bad assets, even though rising, isn\u2019t alarming as yet, but the banking system can\u2019t remain insulated from the real economy and, hence, can\u2019t escape the strains.
\nCrisis ahead?
\nThere has been a dramatic deterioration on the macroeconomic front since the Indian central bank announced yet another rate hike in its October policy, its 13th hike since March 2010, to check persistently high inflation in the world\u2019s second-fastest growing major economy after China.
\nThere are telltale signs of a slowdown everywhere and many have started believing that the economy is heading for a crash landing.
\nIndia\u2019s factory output expanded at 1.9% in September, the slowest in two years, against 6.1% in the year-ago period. In August, it had expanded at 3.6%, much lower than the consensus estimate and the 4.5% growth in August 2010, and worse than the upwardly revised 3.8% growth in July.<\/p>\n
Cumulative growth in the first six months of fiscal 2012, between April and September, slowed to 5% against 8.2% in the same period last year. While manufacturing posted a paltry 2.1% growth year-on-year, its lowest since October 2009, capital goods output yet again turned negative (-6.8%). This is critical as it has direct correlation with investment spending.
\nThe HSBC India Manufacturing Purchasing Managers\u2019 Index (PMI) bounced back in October to 52 after dropping to 50.4 in September, its lowest since March 2009, but services PMI contracted for the second successive month at 49.1, after 49.8 in September, the first contraction since April 2009. A reading above 50 indicates expansion.
\nAmong other slowdown signs, car sales fell for the fourth consecutive month in October, and the 23.77% decline is the sharpest monthly fall in almost 11 years. Indeed, disruptions in production schedules at the country\u2019s largest car maker, Maruti Suzuki India Ltd, contributed to the fall in sales, but high interest rates and rising fuel prices also played a critical role. And if that\u2019s not bad enough, slackening demand in developed markets widened the country\u2019s trade deficit to a four-year high of $19.6 billion in October.
\nGrowth in exports declined to 10.8%, continuing the trend that started in August, even as import growth remained steady at 21.7%.
\nThe trade deficit in the first seven months of the current fiscal has been $93.7 billion, a level not seen in many years, and by the end of the year it may rise to as high as $150 billion, about 8% of India\u2019s gross domestic product (GDP) on the budget estimate of growth. The current account deficit could be around 3% of GDP.
\nAdding to the gloom, indirect tax collections in October dropped 2.5% and gross direct tax collections slipped 0.61%. With demand slowing and corporate profitability being hurt, tax collections are likely to be affected further.
\nAround 2,150 listed firms that have announced their earnings so far have shown a close to 36% drop in net profit even though their sales have been up 22%. High interest cost is one of the contributing factors to the drop in net profit, and there will be no surprise if many of them fail to pay back bank loans. Gross bad debts of listed banks have crossed Rs 1 trillion in September, 33% higher than a year ago, and will rise further as many of the restructured loans will turn bad.
\nWidening fiscal deficit?
\nLower tax collection is not good news for the government as it will not be able to keep the fiscal deficit target at 4.6% outlined in the budget. The government has already raised its market borrowing programme in the second half by Rs 52,872 crore, making this year\u2019s borrowing a record high (Rs 4.7 trillion), but the reason behind the rise in market borrowing, we were told, was lower collections from small savings. If indeed the fiscal deficit overshoots the target, the government will have to borrow even more. This has a direct bearing on the investment cycle as it will push up interest rates and crowd out private investments.
\nThe benchmark 10-year bond yield on Friday touched a 39-month high of 9%, and government bond auctions have been devolving on primary dealers as banks do not have enough appetite for sovereign papers when liquidity is tight. They borrowed Rs 1.27 trillion from RBI on Friday and the daily average cash deficit in the banking system in the past week was in the range of Rs 80,000-85,000 crore.
\nFor RBI (and, of course, for the government), it\u2019s time to worry about growth even though inflation continues to be high and may not drop to 7% by the year-end, as projected by RBI, with oil prices going up. One of the key assumptions of RBI behind pegging wholesale price inflation at 7% by March is a bearish outlook on oil prices. Besides, a falling rupee will also put pressure on inflation as the import of goods will become costlier in rupee terms. The Indian currency has breached the 50 mark against the dollar and is trading at a 30-month low. Inflation has remained persistently above 9% for 10 months in a row and at least 8% for the past 21 months.
\nRBI will not be in a hurry to reverse its monetary policy stance and start cutting rates soon, but it may have to find ways to infuse liquidity in the system, possibly through bond sales, as otherwise the government will find it difficult to raise money from the market and there will be no money for firms to borrow.
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\nWe are close to a crisis and the best thing the government can do at this juncture is push for some reforms and stir foreign investors\u2019 imagination. This can be done, for instance, by raising the foreign direct investment limit in insurance and opening up the retail sector. A cut in expenditure is ideal to contain fiscal deficit at the targeted level, but if that\u2019s too difficult, the government can raise excise duty\u2014which was sharply cut in 2009\u2014even at the risk of adding to inflation. It can also bring down its stake in public sector banks, from 51% to say 33%, to help banks raise money from the market.
\nWhat\u2019s the point in raising the fiscal deficit further to infuse capital in banks and maintain its status as the majority stakeholder when a 26% stake gives a shareholder powers to block any special resolutions and even a so-called golden share can help the government control the banks? Smart administrators see opportunities in a crisis.<\/p>\n","protected":false},"excerpt":{"rendered":"
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