India's banks may begin to see improvement in their net interest margins and income as policy rates stabilize and the economy shows signs of a sooner-than-expected recovery from the COVID-19 pandemic, analysts say.
The Reserve Bank of India held rates steady at its December policy meeting, as expected. The central bank's policy-setting panel decided to continue with its accommodative stance "as long as necessary," according to a Dec. 4 statement. The RBI expects the stance to continue into the next fiscal year that starts April 1, as it seeks to "revive growth on a durable basis and mitigate the impact of COVID-19 on the economy."
System-wide liquidity continues to be in a "large surplus," the RBI said. It also noted that non-food credit growth accelerated and moved into positive territory in November, the first time this fiscal year.
"A stronger economy implies lower [nonperforming assets,] which bode well for [bank] profitability," said Sameer Narang, chief economist at state-run Bank of Baroda. The "overall assessment and direction is positive for banks," he said.
Since loans to the retail and medium- and small-scale enterprises segments are linked to the repo benchmark rate, the RBI's stand-pat decision implies stable margins, he said.
Earnings under pressure
Earnings at Indian banks, especially state-owned lenders, have been under pressure as the RBI cut rates aggressively earlier this year to support the economy that slid into its first technical recession on record. However, the economy contracted a shallower-than-expected 7.5% on year in the July-September quarter, according to government data released on Nov. 27.
Several high-frequency indicators point to the economic recovery gaining traction, with a double-digit growth in passenger vehicle and motorcycle sales, railway freight and electricity consumption in October. Riding on a favorable monsoon rainy season this year, the outlook for the agriculture sector remains bright, according to the central bank.
"Liquidity in the banking system continues to be comfortable. This means the flow of deposits to the banking system also will likely continue. That, coupled with enhanced lending opportunities as economic activity picks up, may bode well for bank net margins," Lakshmi Iyer, president and chief investment officer for debt at Kotak Mahindra Asset Management, told S&P Global Market Intelligence in an email.
The impact on banks' NIMs from the policy decision will "be more of a function of how credit growth picks up," said Krishnan Sitaraman, senior director at CRISIL, a unit of S&P Global. "Status quo has been maintained on interest rates as was expected to balance the accommodative stance to support the economy in the context of rising inflation," he added.
Shifting gears
India's economy "has shifted gears" in the last two months and the economy will likely return to expansion in the second half of the fiscal year to March 31, Shubhada Rao, Yuvika Singhal and Vivek Kumar of QuantEco Research said in a Dec. 4 note.
With inflation expected to outrun the RBI's 2.0%-6.0% target range, "we are of the view that any room for easing rates gets ruled out for the rest of [FY2021]," the QuantEco analysts said.
Profitability of the corporate sector improved in the September quarter, accompanied by a marginal decline in leverage for private manufacturing companies, they said in a separate note on Nov. 27. "Going forward, both [corporate] expenditure and sales can be expected to pick up, almost in tandem," the analysts added.
Nomura expects the RBI to maintain its policy status quo through 2021, though the central bank may gradually moderate surplus liquidity in the coming quarters. For now, "the RBI has continued to prioritize growth and assuaged market concerns of a sudden withdrawal of excess liquidity," Sonal Varma and Aurodeep Nandi wrote in a Dec. 4 note for clients. Overall, the central bank is on a "dovish hold," though the Nomura analysts think it is "increasingly uncomfortable with the sticky nature of inflation."
The measure will eventually help strengthen banks' balance sheets "and possibly reflect in the banks' performance as well," Iyer said.
The central bank had asked banks in April to hold dividends for the last fiscal year, and the decision to nix the payments comes after a review of the second-quarter earnings of the lenders.