Souring bank loans, car sales fuel India economic gloom

India's economic gloom deepened on Wednesday as worsening loan quality at State Bank of India (SBI) rattled investors, Moody's downgraded its outlook for banks, and October car sales skidded 24%, their worst drop in over a decade.

The Reserve Bank of India (RBI) has raised interest rates 13 times since early 2010 but has failed to rein in inflation, which remains above 9%. Instead, asset quality at banks is eroding and growth in Asia's third-largest economy is slowing.

"More softening in demand indicators is likely, so to that extent the light at the end of tunnel is not in sight yet," said Radhika Rao, an economist with Forecast Pte in Singapore.

Global weakness is exacerbating the slowdown for an economy that grew at 8.5% in the last fiscal year but is on track to expand by as little as 7.2% in the current fiscal year, according to some forecasts.

Monetary policy in India can take several quarters to have an impact, and Rao said she expected the effect of the prolonged bout of tightening to persist into the middle of the fiscal year that will start in April.

"The bottom is likely to be reached only around mid or third quarter of next year," she said.

On Friday, India is expected to report that industrial output growth slowed to an annual rate of 3.5% in September, a Reuters poll found, from 4.1% growth in August.

On Tuesday, data showed that growth in merchandise exports, once a bright spot that had seen 82% annual growth during July, had slowed to just 10.8% for October.

Turbulence in the country's biggest export markets, the United States and Europe, prompted officials to predict an export slowdown and a worsening trade deficit in the second half of the fiscal year ending March 2012.

"You are finally seeing the slowdown in exports that we have been talking about for a long time," Trade Secretary Rahul Kullar said on Tuesday.

Banks burdgeon

SBI, which has a 25% market share, disappointed investors on Tuesday - despite beating profit forecasts - by posting a rise in non performing assets and a 35% increase from a year earlier in its provisions against bad loans.

Shares in SBI ended 6.77% lower, their biggest percentage drop since mid-May, as investors grow increasingly wary about declining asset quality in India.

Several banks have stopped lending to state power distributors as well as to property developers and road projects on worries over asset quality.

"With asset quality, given the tightening environment, we anticipate that it will deteriorate over the next 12-18 months, thereby causing an increase in provisioning needs for the banks in FY2012 and FY2013," Vineet Gupta, a Moody's vice president and senior analyst said in a note.

The Bombay Stock Exchange banks index fell 2.62%, and lenders dragged the broader market index down by 1.18%.

Sales of cars, which are sensitive to rising interest rates and the rising cost of fuel, fell nearly 24% in October from a year earlier, their biggest such drop since December 2010, dragged down in part by labour unrest at leading carmaker Maruti Suzuki.

"The macroeconomic scenario is very weak, and that's obviously impacting the numbers," said Joseph George, auto analyst at Mumbai-based brokerage India Infoline.

Demand for cars in India fell for the fourth month in a row after surging 30% in the previous fiscal year.

India's sluggishness is expected to persist in the near term.

"The outlook on growth is negative; we may see more disappointing data sets on macroeconomic parameters in the coming months," said Nitesh Ranjan, economist with Union Bank of India.