With growth in domestic economy moderating and slowdown in credit cycle, the deterioration in asset quality of the banks will emerge as a challenge for the banking sector said the Reserve Bank of India (RBI) in its Financial Stability Report (FSR), released on Thursday.
The report, in which the RBI presents half-yearly assessment, said that India’s financial system is stable and can withstand global shocks, but there are weak spots like decelerating growth, rising bad loans, high inflation and rising fiscal deficit, which needs to be addressed.
“With further slowdown in credit cycle expected on the back of higher interest rate environment and a slowing economy, deteriorating asset quality will emerge as a challenge for the banking sector,” said the RBI in its report. “The domestic financial system remains stable in the face of an adverse international backdrop ... soft spots (are needed) to be addressed going forward.”
The gross non-performing assets (NPA) ratio of banks has increased from 2.3% as at the end of March 2011 to 2.8% as at the end of September 2011.
The major sectors that contributed to the increasing trend in NPAs were priority, retail, real estate and infrastructure. Their combined share in gross NPAs of the banking sector stood at 85% as at the end of September 2011.
As per the report, India’s current account deficit is expected to widen further on the back of higher oil prices and sharp increase in imports of bullion, machinery and electronics. Inflation risks remain high and slowdown in revenue collections and higher spending on subsidies may make it more challenging to achieve the fiscal deficit target of 4.6% in the fiscal year ending March.
“Recent data indicate further widening of the trade balance. Consequently, Current Account Deficit (CAD) which increased during Q1 of 2011/12 is expected to widen further,” report said.
India’s CAD swelled to $14.1 billion in its fiscal first quarter, nearly triple the previous quarter’s tally. The trade deficit for 2011-12 is expected to widen sharply to between $155 billion and $160 billion from $104 billion a year ago, posing further downside risks to the rupee, which hit a record low last week.
The RBI said risk aversion sentiment and the depreciation of the rupee could complicate refinancing of foreign currency convertible bonds and external commercial borrowings by Indian companies.