Cutting corporate debt

Banks will struggle to grow in the coming quarters

Indian companies are deleveraging and the trend is likely to continue in the foreseeable future. As a recent report in this newspaper showed, in 2020-21, the debt-to-equity ratio of listed firms dropped to a six-year low of 0.59, compared to 0.73 in the previous year. Given the state of credit flow and economic activity, in general, it is likely that the process is continuing. This is in sharp contrast to the high-growth years, both before and after the global financial crisis, when Indian companies were accumulating debt to increase investment. A large proportion of that debt did not help firms and turned into non-performing loans for banks as the Indian economy lost momentum. The banking system has struggled for years with high levels of non-performing assets and has not fully recovered yet. The government, for instance, has infused over Rs 3.4 trillion into public sector banks since 2014.
 

However, compared to the situation until a few years ago, the state of both the corporate and the banking sector has improved. The impact of pandemic-related disruption has been considerably lower than anticipated for both corporations and the banking system. In fact, earnings have improved for large corporations over the last few quarters. The deleveraging process in the corporate sector is also being helped by buoyancy in the stock market, which has enabled firms to raise record sums. While the strengthening of the corporate balance sheet is encouraging, it also reflects the unwillingness to invest and highlights the underlying weakness in the economy. As the Reserve Bank of India’s recent report on the banking sector noted, non-financial private firms have been net savers over the last three years. This also underscores challenges the banking sector is likely to face in the near to medium term. While profitability in the sector improved in recent quarters partly because of lower cost and higher trading gains, things might soon change with the normalisation of monetary policy and higher interest rates. Also, as the banking regulator has highlighted, asset quality could be impacted once the pandemic-related support extended to borrowers begins to unwind. It is also worth noting that write-offs have been the primary driver of improvement in asset quality over the last few years.

The biggest challenge for banks, however, could come from sustained lower demand for credit. Banks have been focusing on retail lending, but that too has limits, particularly in the given environment where a large number of households have suffered income losses and would be looking to repair their balance sheets. The latest numbers show that lending to industry in 2020-21 grew by 0.03 per cent after witnessing a contraction in the previous year. While borrowing by large corporations contracted, lending improved in the small and medium segments, largely because of the credit guarantee scheme of the government. Credit to industry went up by 3.3 per cent in the first half of the current fiscal year. Credit growth is likely to remain tepid because of the relatively low level of industrial capacity utilisation and weak underlying demand in the economy. But lending in the retail segment remains strong. Outstanding retail loans have surpassed total lending to the services sector. At a broader level, however, banks would struggle to grow over the coming quarters in the absence of an overall credit demand revival.