Financial stability around the world continues to improve, says the International Monetary Fund’s (IMF’s) Global Financial Stability Report released on Wednesday. But it also points out that while emerging markets may be more resilient now, there are considerable risks from rising corporate debt, especially in a scenario of increasing global risk premiums and rising protectionism. India, says the report, will be among the countries that will see the greatest deterioration in corporate balance sheets.
India starts off on a weak footing. The current debt that is at risk is the highest among large emerging markets. About one in every five rupees has been lent to companies that have an interest coverage ratio—a measure of a company’s ability to pay its debt—of less than one. As the chart above shows, this debt burden will worsen with rising protectionism and risk premiums. For India, this debt at risk could increase by as much 6.7 percentage points. Such a scenario is already underway. For instance, US President Donald Trump’s signing of an executive order on Wednesday will make it harder for US firms to import steel.
For Indian banks, this will come as bad news at a time when they are struggling with at least Rs7 trillion in toxic loans and thin provisioning buffers. The IMF statistics don’t make for good reading. India’s gross bad loans ratio is among the worst, next only to Russia. About 79% of Indian banks’ assets have provisioning needs in excess of their profits; about 77% of assets will be backed by tier-1 capital ratios of 10% (To be sure, most of these are with public sector banks which theoretically have government backing, but any extra capital from the government will be at the cost of the fiscal deficit). IMF estimates that about one-third of the Indian banking system needs to set aside at least three years of earnings to provision adequately for bad loans.
The IMF estimates may well be overly conservative. But just earlier this week, the Reserve Bank of India advised banks to set aside more money against even good loans in stressed sectors. According to a Credit Suisse analysis, exposure to stressed sectors such as telecom and power forms a significant portion of their balance sheets. Setting aside more money to cover the risk of default will hit earnings by up to 15% for some banks, the brokerage said.