Explained | Will the war in Ukraine rock India’s 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: S&P Global earlier this week forecast that banks in India would face “headwinds” as a result of the Russia-Ukraine conflict. The rating agency pointed to rising inflation and borrower “stress” that could affect companies’ ability to fully repay loans.

How does a war in Eastern Europe affect India?

The war has affected the production and transportation of a wide variety of raw materials and goods. For example, Ukraine is the main source of sunflower oil imported to India. Deliveries, of course, have been hit and will continue to push up retail cooking oil prices.

The conflict has also forced Ukraine to shut down two neon factories that account for about 50% of the world’s semiconductor manufacturing needs. As semiconductors become scarcer, user industries are bearing the brunt. The global shortage of chips has already meant that the waiting time for the delivery of new premium cars in India has increased to several months. And with major automakers reporting sales declines for January and February, the earnings outlook for these companies and their suppliers looks significantly clouded. The domino effect on automotive and other industry supply chains could affect the ability of companies, particularly medium-sized and small companies, to fully service their loans.

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

The oil has been boiling since Russia invaded Ukraine on February 24. After surging to $139 a barrel — near historic highs — Brent crude was trading at $106 a barrel on Friday. As India’s state-owned oil distribution companies will sooner or later increase retail prices for gasoline and diesel, the higher transportation costs will inevitably impact the prices of goods, from agricultural produce to raw materials for factories to finished products being shipped to store shelves, thereby reducing the Inflation is accelerating across the board.

Higher input costs for manufacturers and service providers would put them in a difficult position, as they would have to choose between passing the price increases on to consumers – risking already weak demand – or hurting their profitability if they choose to absorb the impact to absorb. Again, smaller companies, which rely most heavily on bank credit, are likely to be hit hardest. If the war in Europe lasts longer, Indian banks could face delays in repaying loans or even write them off as bad.

Separately, the rupee is expected to weaken as the dollar benefits from a global flight to less risky assets and the start of the Federal Reserve’s calibrated monetary tightening to bring inflation down from a 40-year high in the world’s largest economy World rein against the US currency. With the exchange rate affected, importers would have to shell out more rupees for the same dollar value of imports than before. Unless demand grows, allowing them to sell more volume, a weaker local currency eats away at their profits and leaves them with less cash to service loans.

Official data for February shows total imports of goods yoy growing faster than exports, widening the current account deficit (CAD). CAD expansion is likely to see the rupee weaken further from 75 to 77.5 to a dollar by March 2023, Crisil Ratings said on March 17.

Rising inflation, which is already just above the RBI’s upper tolerance level of 6%, could prompt the central bank to raise interest rates. This means that companies that are likely to be offered lower profits will have to pay more interest.

Earlier this month, India Ratings said the rise in commodity prices could lead to an extended working capital cycle for small and medium-sized enterprises (SMEs) and weaken their ability to service debt.

Why is the situation particularly worrying for Indian banks?

India’s lenders were already struggling to deal with an overhang of distressed assets or non-performing loans even before the pandemic severely impacted macroeconomic momentum.

In its December 2021 Financial Stability Report, RBI warned that from a gross non-performing asset ratio of 6.9% in September 2021, commercial banks would likely see a rise to 8.1% in a baseline scenario, and possibly a rise to 9.5% by September 2022 in a “severe stress” situation.

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