International rating agency Moody's on Wednesday retained its negative outlook on the domestic banking system, citing high leverage in the corporate sector that may prevent any meaningful recovery in asset quality.
"Our outlook for the country's banking system remains negative, as it has been since November 2011.
"The negative outlook reflects our view that high leverage in the corporate sector could prevent any meaningful recovery in asset quality, notwithstanding a moderate rebound in economic growth," the agency Moody's Investors Service said in a note issued from Singapore.
The report further said continuing poor asset quality, wherein the NPAs levels are set to touch 4.5% of the system, will require continued provisioning and strengthened capital buffers. After provisions, profitability of public sector banks will generate insufficient internal capital for loan growth, the report added.
The negative outlook pertains mainly to the public sector banks as they represent more than 70% of total banking system assets. These banks have experienced higher growth rates in non-performing and restructured loans, as well as greater weakening in profits, than their private sector peers, Moody's said.
The report says while these trends are unlikely to improve for public sector banks, in contrast, private sector banks have stronger margins, reserves, and capital levels, which serve as buffers against conditions that remain challenging.
On growth, which inched up to surprising 5.7% in the first quarter of the current fiscal after logging in sub-5% growth in the past two fiscals, Moody's said GDP will pick up moderately this fiscal, but remains constrained by the high interest rates due to inflation.
"Our growth estimates reflect expectations for a cyclical recovery and do not incorporate assumptions of reforms which may be implemented by the new government. We expect that some policies may be formulated within the 12-18 months horizon of this outlook, but it will take longer to see an impact on the real economy.
"Our base-case forecast for GDP is 5% for the current fiscal and 5.6% for FY16, compared to 4.7% in FY14 and 4.5% in the year before," Moody's said.
This is one of the lowest by any agency for this fiscal as even last week the World Bank has pegged 5.6 per cent GDP print for 2014-15. While the government forecast is 5.5-6 per cent, the Reserve Bank has put a conservative 5.5% GDP growth for this fiscal.
On the high leverage of the domestic corporates, the report said India Inc will remain highly leveraged, representing an obstacle to a cyclical recovery in asset quality.
"The broad corporate sector (all listed non-financial companies) has a debt-to-equity ratio of over 3 times. Of the outstanding debt, 16% is issued by borrowers with interest coverage ratios below 1 times, and 36% is issued by borrowers with coverage ratios below 2 times.
In particular, corporates engaged in infrastructure projects face both structural and cyclical challenges, as projects remain stalled by regulatory roadblocks and operationally uneconomic since they were conceived with higher growth assumptions, the report said.
"Without a stronger economic recovery, significant deleveraging will only occur beyond the horizon of this outlook," the report cautioned.