Gene Fang, Vice President - Senior Analyst, Nick Caes, Associate Analyst, Financial Institutions Group, Moody's Investors Service Singapore Pte. Ltd.
Last Monday, India's government unveiled its interim budget for the fiscal year starting in April, allocating INR112 billion ($1.8 billion) for capital injections into public-sector banks. The allocation is credit negative for public-sector banks because it is much smaller than the INR250-INR360 billion ($4.1-$5.8 billion) that we estimated the banks needed to meet a minimum Tier 1 ratio of 8% in the fiscal year ending March 2015. Our estimates assume the banks make adequate provisions to meet a minimum 70% coverage ratio under a range of potential asset-quality outcomes.The budget allocation is also smaller than the amounts the Indian government has injected into public-sector banks in the past three fiscal years.
Indian public-sector banks' need for significant external capital is a result of an increase in non-performing loans (NPLs) owing to the country's slowing economy and infrastructure bottlenecks, and profitability that is insufficient for internal capital generation to fund loan growth. As of December 2013, rated public-sector banks reported an average gross NPL ratio of 4.3%, up from 3.4% in March 2013, and we expect them to continue rising in fiscal 2015. The 90 basis point increase in the March-December 2013 period exceeds the average increase of 50 basis points for the fiscal year ended March 2013 and 78 basis points for fiscal 2012.
As a result of rising NPLs and lower profitability, provision expense rose to 65% of rated public-sector banks' pre-provision income for the first three quarters of the fiscal year from 49% a year earlier. Indian public-sector banks' loan-loss reserves remain lower as a percentage of gross NPLs than those of private-sector banks or banks in other emerging markets.
Another reason public-sector banks require external capital is that we expect loan growth rates to remain similar to the 16% year-on-year average recorded as of December 2013. Moreover, the introduction of Basel III raises the amount of capital that Indian banks will need to meet minimum targets. Rated Indian banks reported Tier 1 ratios under Basel III that are 34 basis points lower, on average, than under Basel II in fiscal 2014.
Without sufficient government capital infusions, public-sector banks will be challenged to maintain minimum Tier 1 ratios of 8%. Although State Bank of India (SBI, Baa3 stable, D+/ba1 negative) successfully raised equity from the public markets in late January, it finalized the transaction at a lower price and volume than it originally targeted. Most other public-sector banks trade at valuations below SBI, indicating that markets are not yet receptive to further equity offerings from these banks. There are also caps on the equity exposure of Life Insurance Corporation of India (Baa3 stable), a state-owned insurer that provided INR75.6 billion of equity to rated public-sector banks in fiscal 2012.
The Indian government's interim budget is subject to revisions if a different government is chosen following elections in May. However, if no clear coalition wins, the current government may continue to operate under this budget until new elections are held.
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