India’s second wave of Covid-19 infections pose an increased risk to the country’s fragile economic recovery and its banks, Fitch Ratings said.

Accordingly, Fitch expects a moderately worse environment for India’s banking sector in 2021, but headwinds would intensify should rising infections and follow-up measures to contain the virus further affect business and economic activity.

Lately, India’s active Covid-19 infections have been increasing at a rapid pace; new infections have exceeded 100,000 a day in early April 2021, against 9,300 in mid-February 2021.

Fitch forecasts India’s real GDP growth at 12.8 per cent for the financial year ending March 2022 (FY22).

“This incorporates expectations of a slowdown in 2021 due to the flare-up in new coronavirus cases but the rising pace of infections poses renewed risks to the forecast.”

“Over 80 per cent of the new infections are in six prominent states, which combined account for roughly 45 per cent of total banking sector loans. Any further disruption in economic activity in these states would pose a setback for fragile business sentiment, even though a stringent pan-India lockdown like the one in 2020 is unlikely.”

As per Fitch, operating environment for banks will most likely remain challenging against this backdrop.

“This second wave could dent the sluggish recovery in consumer and corporate confidence, and further supress banks’ prospects for new business. There are also asset quality concerns since banks’ financial results are yet to fully factor in the first wave’s impact and the stringent 2020 lockdown due to the forbearances in place.”

“We consider the micro, small and medium enterprises (MSME) and retail loans to be most at risk. Retail loans have been performing better than our expectations but might see increased stress if renewed restrictions impinge further on individual incomes and savings. MSMEs, however, benefited from state-guaranteed refinancing schemes that prevented stressed exposures from souring.”

According to Fitch, private banks are more exposed to retail but also have much better earnings capacity, contingency reserves and core capitalisation to withstand stress on their portfolios.

In contrast, state-owned banks remain more vulnerable as their prevailing weak asset quality and greater participation in relief measures are not commensurate with their limited loss-absorption buffers.

“The extension of the MSME refinancing scheme until 30 June 2021 will alleviate short-term pain, but potentially add to the sector’s exposure to stressed MSMEs, which was around 8.5 per cent of loans, Fitch estimated.

“Nevertheless, we believe the second wave could have a more modest impact than the initial wave on our assessment of the operating environment in India, based on global examples of residents and economies adjusting their activities – including much less stringent and more localised restrictions than last year.”

“The government’s more accommodative fiscal stance may also mitigate some short-term growth pressures. However, inoculating India’s large population in a fast and effective way will be important to avoid repeated disruptions.”