Budget 2021 expectations | Continuation of RBI-directed funding in near term would be key to NBFC revival

The non-banking financial companies (NBFC) have grown and evolved over the past two decades, touching and impacting all the key segments of the economy. While the requirement of the players may vary depending on their target segment, liability management has been a key concern for all of them since 2018-19. This is partly because of their own fast-paced growth and the limited overall credit flow to their key target segments, primarily small and micro enterprises, which could have a cascading impact on the financial health and sustainability of their borrowers.

Apart from micro, small and medium enterprises (MSMEs), the focus would remain on the affordable housing sector under the goal of ‘housing for all’ by providing tax incentives to homebuyers and builders, which are likely to be extended or further improved. Both MSMEs and the housing sector would have a multiplier effect on the overall economic activity and would be key for recovery post the COVID-19 pandemic.

The Reserve Bank of India (RBI) and the Government of India (GoI) had stepped in on a timely and adequate basis to address the risks, which mounted on the sector with the onset of the pandemic. Both ensured adequate liquidity to the sector in the form of targeted lending – i.e., Targeted Long-Term Repo Operations (TLTRO), Partial Credit Guarantee Scheme (PCGS) and Special Liquidity Scheme (SLS). The GoI also alleviated the concerns of the lenders by extending guarantees (Emergency Credit Line Guarantee Scheme – ECLGS) for their incremental lending. Incremental credit flow is expected to positively stimulate their borrower risk profiles. That said, the banking sector liquidity is still quite high at 6-7 percent of their overall credit indicating low investor/lender confidence.

We expect the Budget for FY2022 to outlay the continuation of some of the above-mentioned liquidity and guarantee schemes in FY2022 to ensure near-term funding availability for NBFCs and provide a guidance on the medium-term support framework for the sector, which could boost investor confidence and would be key for a sustainable revival.

We expect the asset quality pressures to manifest in H2 FY2021 and remain elevated in FY2022 as the various borrower forbearances taper off. However, regular fund flow to these borrowers would be crucial for their revival going forward. We expect the NBFC sector to grow at a moderate 7-9 percent in FY2022, essentially because of the funding-related concerns, even when demand is expected to be better enough to push the growth to the mid-double digits if sectoral funding and liquidity remain commensurate. NBFCs would require about Rs. 1.9-2.2 trillion of the fresh funding, apart from refinance of the existing maturities, to support the estimated moderate growth in FY2022.

Domestic funding sources are either near their thresholds (like banks) or may take somewhat longer to recover to past levels (like mutual funds). Other long-term domestic sources like insurance and provident/pension funds largely focus on higher-rated (AA rated and above) or government entities. While previous Budgets had nudged the regulators to expand the investment scope to lower-rated papers in a bid to deepen the bond markets, very little has materialised so far. This is an opportune time to push forward this reform in the current scenario to deepen the capital debt markets. Some near-term easing of overseas funding regulation – i.e., foreign portfolio investment (FPI)/external commercial borrowing (ECB) investment guidelines, which have been tightened on certain aspects, namely investment concentration, group-related exposures, etc, until the domestic markets find their feet would also support credit flow to the sector.

The long-standing expectation of a permanent NBFC refinance window from the RBI or the designation of an existing institution/creation of a new institution as the backstop for NBFCs would quell the concerns of most lenders and investors. This is crucial considering the sizeable nature of the NBFC sector, which accounts for 20-25 percent of the credit exposure in the country, and its systemically critical position.