Explained | Will the war in Ukraine shake Indian banks?

Could a distant war have a domino effect on Indian lenders? What are some of the challenges?

Could a distant war have a domino effect on Indian lenders? What are some of the challenges?

The story so far: Earlier this week, S&P Global predicted Indian banks would face “headwinds” due to fallout from the Russia-Ukraine conflict. The rating agency reported rising inflation and “stress” from borrowers that could affect companies’ ability to repay their loans in full.

How does a war in Eastern Europe affect India?

The war impacted the production and circulation of a wide range of raw materials and commodities. Ukraine, for example, is the main source of imported sunflower oil in India. Supplies have naturally been hit and are expected to drive up retail edible oil prices further.

The conflict has also forced Ukraine to shut down two neon factories that account for around 50% of the world’s supply needed to manufacture semiconductors. As semiconductors become scarce, user industries suffer. Already, the global shortage of chips has led to the waiting period for the delivery of new high-end cars in India being extended by several months. And with major automakers reporting lower sales for January and February, the earnings outlook for these companies and their component suppliers appears to be significantly clouded. The domino effect on automotive supply chains and other industries could hurt the ability of businesses, especially small and medium-sized businesses, to fully repay their loans.

What other factors can affect a company’s ability to repay its loans?

Oil has been boiling since Russia invaded Ukraine on February 24. After climbing to $139 a barrel — near all-time highs — Brent prices were at $106 a barrel on Friday. As India’s state-run oil marketing companies are sure to raise retail gasoline and diesel prices sooner rather than later, rising transportation costs can only trickle down to prices. goods, from agricultural products to raw materials for factories and finished goods destined for store shelves, thus accelerating inflation at all levels.

Higher input costs for manufacturers and service providers would put them in a difficult situation, as they would have to choose between passing on price increases to consumers – thus risking already tenuous demand – and hurting their profitability further. they choose to absorb the impact. Here again, small businesses, the most dependent on bank credit, will inevitably be the hardest hit. If the war in Europe drags on, Indian banks could find themselves facing delays in loan repayments or even having to write them off as “bad”.

Furthermore, with the dollar benefiting from a global flight to less risky assets, as well as the start of calibrated monetary tightening by the US Federal Reserve to contain inflation from a 40-year high in the world’s largest economy. world, the rupee is expected to weaken against the US currency. With the impact of the exchange rate, importers would have to shell out more rupees for the same dollar value of imports than before. Unless demand expands, allowing them to sell more volume, a weaker local currency eats away at their profits, leaving them with less cash available to service loans.

Official data from February shows that overall imports of goods are growing faster than exports from a year earlier, widening the current account deficit (CAD). The widening CAD is likely to further weaken the rupee to 77.5 per dollar by March 2023 from 75, Crisil Ratings said on March 17.

Rising inflation, which is already just beyond the RBI’s 6% upper tolerance limit, could push the central bank to raise benchmark interest rates. This means that more interest will have to be paid by companies which would likely face the prospect of less profit.

Earlier this month, India Ratings said rising commodity prices could lead to a tight working capital cycle for small and medium-sized enterprises (SMEs), weakening their ability to service debt.

Why is the situation particularly worrying for Indian banks?

Indian lenders were already struggling to deal with a surplus of non-performing assets or bad debts even before the pandemic severely damaged overall economic momentum.

In its December 2021 Financial Stability Report, the RBI warned that from a gross non-performing asset ratio of 6.9% in September 2021, commercial banks risk seeing the metric rise to 8.1% in a baseline scenario, and eventually rise to 9.5. % under “severe stress” by September 2022.

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