Moneycontrol Pro Panorama | Fault lines are running deep for markets

Dear Reader,

The Reserve Bank of India’s Financial Stability Report (FSR) says gross non-performing assets of scheduled commercial banks (SCBs) may increase from 6.9 percent in September 2021 to 8.1 percent by September 2022 under its baseline scenario and to 9.5 percent under conditions of severe stress. That suggests the bad loan problem is going to get worse for banks.

But there’s another way to look at those numbers. In July this year, the FSR said, “Macro stress tests indicate that the gross non-performing asset (GNPA) ratio of SCBs may increase from 7.48 per cent in March 2021 to 9.80 per cent by March 2022 under the baseline scenario and to 11.22 per cent under a severe stress scenario.” In other words, the worries over bank bad loans have lessened.

That’s not all. The FSR report brought out in January this year, before the second COVID wave hit India, said, “GNPA ratio of all SCBs may increase from 7.5 per cent in September 2020 to 13.5 per cent by September 2021 under the baseline scenario; the ratio may escalate to 14.8 per cent under a severe stress scenario.” Well, the GNPA ratio at end-September 2021 was 6.9 percent, almost half of what was predicted in January under the baseline scenario. Could it be that the FSR is crying wolf?

But then, it’s the duty of the FSR to flag the risks, so that actions are taken to prevent them from happening. What risks are the latest FSR flagging?

The FSR points to several of them. These include the loss of momentum in the global recovery; persistent inflationary pressures; shifts in monetary policy stances across important advanced economy central banks; a stronger US dollar; high energy prices; the tapering of capital flows to emerging market bonds and equities; Omicron; the slowdown in world merchandise trade volumes; vulnerabilities arising out of the rapid growth of decentralised finance, private equity markets and crypto currencies; very high sovereign debt levels; elevated equity market valuations in India; rising bad debts in the consumer finance portfolio and deterioration in quality of new borrowers and incipient stress in the Micro, Small and Medium Enterprise (MSME) sector.

To that long list, we would add the threat of a hard landing in China, geopolitical worries and adverse weather conditions arising out of climate change.

True, Indian banks are in better shape than before the pandemic, so are the bigger firms and we have massive forex reserves. As RBI Governor Shaktikanta Das says in the foreword to the FSR, “Financial institutions in India have remained resilient amidst the pandemic and stability prevails in the financial markets, cushioned by policy and regulatory support. Balance sheets of banks remain strong and capital and liquidity buffers are being bolstered to mitigate future shocks, as reflected in the stress tests presented in this report.”

But the most important question for 2022 is this: So far, the markets have remained impervious to this litany of risks because of the liquidity pumped in by central banks. What happens when the taps are turned off? The answer will determine the course of not just global markets, but also the economic recovery.

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Manas Chakravarty

Moneycontrol Pro