Home / Opinion / Views /  Banks will take 12-18 months to show covid symptoms

Early signs suggest that government measures such as the Emergency Credit Linked Guarantee Scheme (ECLGS) is providing some relief to covid-impacted businesses. Additionally, the Reserve Bank of India’s (RBI) moratorium and its subsequent one-time-restructuring (OTR) scheme have contributed to keeping the non-performing asset (NPA) levels of banks in check. Following a Supreme Court (SC) stay order, banks have not tagged the loans of specific borrowers as ‘NPAs’ since August 2020. Institutional lenders, though, have started reporting portfolio-level pro-forma NPAs (i.e., the gross NPA rate) in the absence of an SC order. An incremental 1 trillion of debt is estimated to have become non-performing. This is just 16% more than the currently recognized NPA level. Given the economic shock, this warrants a sigh of relief, even if only temporary. Further, it is estimated that less than 2%-3% of borrowers had requested an OTR as of 31 December 2020. While these signs are encouraging, it may be too early to celebrate. An exploration of the possible reasons for today’s less-than-expected stress levels may provide clues to how India’s NPA trajectory will play out.

First, consider pre-covid restructuring in the micro, small and medium enterprise (MSME) sector. According to a statement in Parliament by India’s minister of state for finance, 651,000 MSME borrowers had got restructuring done till 31 March 2020. These MSMEs, with exposures below 25 crore, had received a debt-servicing cushion even before India’s lockdown. Thus, some of the most vulnerable borrowers did not line up for a subsequent OTR. Common formats of restructuring tend to reduce a firm’s debt-servicing burden for 12-18 months. While such debt can turn into an NPA even during this period, a significant number of these MSMEs are unlikely to impact the country’s overall NPA count before September 2021.

Before delving into other hypotheses, let’s look at the money supply dynamics. Over the last nine months of 2020, currency with the public (CPW) increased by around 3.2 trillion. This was the fastest-growing major component of money supply during that period. Further, demand deposits (money in current and savings accounts) held by the public started surging from October 2020. However, relatively stable term deposits have not shown any change in their growth pattern. To the extent that credit creates deposits, one may attribute at least a portion of India’s demand-deposit growth to the enhanced credit availability to businesses.

Now examine liquidity management. Till 8 January 2021, under the ECLGS, 1.69 trillion was disbursed to 4.25 million borrowers. This scheme allowed for an incremental 20% exposure for business borrowers that were no more than 30 days delinquent on repayments as of February 2020. An incremental 20% of loan value cannot cover the entire cost of business operations, but this incremental debt, if kept in a savings or current account can be used to service debt for 12-24 months. While such businesses may remain in pure sustenance mode, they are unlikely to add to India’s NPA burden, at least for most of 2021-22.

Business promoters may have chipped in with their own resources to support their businesses right from the onset of covid. To an extent, this could explain the post-covid spike in currency with the public. The annual reports of private companies for 2020-21, which will mostly be available in the second-half of 2021-22, would throw more light of their cash positions and equity infusion by promoters. That would test this hypothesis, but till then, the risk guard should not be lowered.

The uncertainty of the situation is reflected by a wide dispersion in market expectations of system-wide gross NPAs in 2021-22. These range from 5% to 11%. This is more optimistic than RBI’s base case estimation of 13.5% gross NPAs by September 2021. These projections will be tested either when the restructuring period gets over or when the effect of credit-infused liquidity wears off. The first-half of 2021-22 may see some weak signals on true credit quality, but the second half would be when a large number of borrowers may have to start bearing their full debt-servicing burden. In 2021-22, however, the reported NPA numbers may be closer to the market’s expectations than RBI’s.

Fiscal year 2022-23 is when banks are finally likely to show symptoms of the covid crisis. That is when a larger number of restructured accounts will start bearing their full debt-servicing burden; credit-infused liquidity may also thin out. While rapid gross domestic product (GDP) growth expected in 2021-22 will support business recoveries, NPA levels after that will likely rise. In 2019-20, the median interest coverage ratio, a measure of debt serviceability, was around 2.0. The ratio is earnings before interest, tax, depreciation and amortization (EBITDA) by Interest expense. EBITDA tends to bear a close correlation with nominal GDP, which is projected to reach 210 trillion in 2021-22, up from 203 trillion in 2019-20. If earnings follow a similar trajectory, then an EBITBA of 200 in 2019-20 will become, say, 210 in 2021-22. Interest expenses, however, will grow at a faster clip because of pent up debt servicing and credit build up. The system-wide coverage ratio will go below its pre-covid level, suggesting higher default risk in 2022-23 than in 2019-20.

Only if the growth momentum of 2021-22 is maintained the year after can the situation be saved. Else, the ravages of covid will show on the health of our banks in 2022-23.

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