SMEs, real estate to drive asset quality deterioration in India, China: S&P

Emerging markets face slippage, volatile capital flow risks

Against the backdrop of the Coronavirus (Covid-19) pandemic and its aftermath, small and medium enterprises (SMEs) will lead asset-quality deterioration, particularly for countries like Turkey, South Africa, India, China, Indonesia, and Thailand.

Tourism and export-oriented SMEs are more vulnerable in this challenging environment, according to rating agency Standard and Poor’s (S&P).

Apart from SMEs, real estate is another source of asset quality pressures for banks in emerging markets. However, the immediate risks appear manageable, S&P said.

Stress in Indian SMEs is somewhat tempered by the government's guarantee of new loans taken by SMEs, up to 20 per cent of their aggregate loans, thereby easing liquidity pressure for SMEs.

In China, total exposure to SMEs is small but has risen rapidly in the past few years as the government encouraged lending to this segment. Russian banks have manageable exposure to SME-related risk since large and mid-size businesses dominate the economy.

The Covid-19 pandemic and its aftermath will continue to dominate the credit story for emerging markets in 2021. The banking systems in emerging markets including India face common risks like the expected deterioration in asset quality indicators as regulatory forbearance measures are lifted in 2021. Other risks they may face include a volatile geopolitical environment or domestic policy uncertainty. For a few, vulnerability to abrupt movements in capital flows also pose a risk.

The rating agency, in its update on emerging markets, said real estate is another source of risk. The uncertainty and potential long-term impact from the Covid-19 andemic might bring structural changes to the commercial real estate segment.  These changes will come via shifts in consumer preferences towards online shopping, more flexible work arrangements, and cost-cutting measures from consumer-driven businesses.

In India, many real estate companies are suffering from a combination of low sales velocity and weak prices, which may mean that a few companies will resort to restructuring their debt. That said, Indian banks' exposure to this sector is relatively lower than their EM counterparts'.

Russian banks have learnt from the previous crises and keep their exposure to real estate and construction rather low, at about 8 per cent of total loans at mid-2020. Pre-Covid-19 oversupply in China, Thailand, and Malaysia exacerbate the risks.

Turning to macro scenario in EMs, S&P said given the exceptionally low interest rates in several developed markets, banks in emerging markets with sound credit fundamentals to retain good access to international capital markets.

The non-performing loans may continue to increase and cost of risk to stabilise at high levels as central banks start to remove regulatory forbearance measures.  Banks will start recognising the full extent of asset quality deterioration.

Reserve Bank of India in its Financial Stability Report (FSR) released early this month stated that banks’ gross non-performing assets (GNPAs) may rise sharply to 13.5 per cent by September 2021 from the 7.5 per cent in September 2020. Under the severe stress scenario, GNPA could touch 14.8 per cent in September 2021.

S&P said like peers in developed markets, EM central banks acted swiftly through a combination of lifting some regulatory requirements (particularly for problem loans recognition) and liquidity injection. This was done to help banks cope with the severe economic contractions.