This RBI report is a cautionary tale, especially at a time when the stock markets appear to be at divergence with the real economy. Here are some key takeaways from the Financial Stability Report for July 2020.
Macro risks are still quite elevated
|Projected GDP||Year 2019||Year 2020 (E)||Year 2021 (E)|
The projected GDP contraction in 2020 is much sharper in the case of developed economies compared to emerging markets. However, there are a few thingsto remember. Firstly, the numbers indicate that it will take more than a couple of years to revert back to the pre-COVID levels of growth. Secondly, in terms of purchasing power, the impact of a 3% contraction in emerging market GDP will be much more severe than an 8% contraction in developed markets GDP. That is because most developed economies have fairly sophisticated and matured social security systems. Thirdly, within the emerging markets universe, the impact is likely to be sharper in the case of economies like India, where the lockdown has been longer and more stringent.
Consumer confidence, manufacturer optimism and credit
The report has highlighted that the lockdown could have deeper implications for supply and demand. The demand side has been hit by lower income levels as well as dented consumer confidence leading to risk aversion. The supply side has been impacted by a financial crunch as well as severe disruptions to the supply chain. The liquidity stress, according to the RBI FSB report, has hit the cash levels of manufacturers, service providers and consumers. RBI expects lag effect of lockdown on demand to last longer; as will the supply chain effect.
Figure 1 - Quarterly Credit Growth across key segments
The low level of consumer confidence is evident in the way credit growth has panned out in the last 8 quarters. The March 20 quarter only captures the initial effect of the pandemic but the credit impact was already visible as a lead indicator. Retail and wholesale credit has been trending lower with wholesale credit taking a much sharper hit as shown in the chart.
Gross NPAs and capital adequacy
RBI has some real concerns on NPAs over next few quarters based on macro stress tests.Gross NPAs of all scheduled commercial banks is expected to increase from 8.5% in Mar-20 to 12.5% in Mar-21. RBI has warned that this ratio could escalate to 14.7% in a worst case scenario. Assuming a median GNPA number of 12.5%, we are already talking about the highest level of banking NPAs in history. Effectively, all the efforts made in the direction of NCLT, recoveries, loan rescheduling and write-offs may virtually come to nought.
The capital adequacy ratio had fallen marginally in the Mar-20 quarter to 14.8%. But the real worry could be what happens in the quarter ended Mar-21. If the gross NPAs rise by over 400 bps then one can expect sharply higher provisioning and a drop in the CRAR. That would be a big worry for the Indian economy in general and the RBI in particular.
Finally, what happens post the moratorium?
That is the billion dollar question for the RBI. As of now the moratorium is scheduled to end in Aug-20 but ground reports suggest a likely extension till Dec-20. That is just postponing the inevitable. The table captures the share of overall loans under moratorium for the various categories of financiers in India.
Clearly, PSBs, SFBs, UCBs and NBFCs are the most impacted by the moratorium. Private Banks and foreign banks have seen less of an impact. Of course, these are numbers as of Mar-20 and most banks have reported a reduction in moratorium loans in the June quarter. If you look at the PSBs, the chunk of the moratorium requests has come from individuals and MSMEs. That is also true on an overall basis.
This is a challenge because the impact of the withdrawal of the EMI moratorium continues to be an X-factor, especially when the economy is just about rebounding from lower levels. In fact, the moratorium impact could be a key deciding factor on how banking stress plays out in the rest of the year.