Weak rupee upsets loan recovery math

The festering wounds of the banking sector are getting a lot worse. There is more pain in store with a sharp plunge in the rupee in the last couple of months. This means it has thrown the loan repayment capacity of corporates into further doubt.

The math is simple. A weak rupee makes imports costlier for businesses, thus eroding their margins and profitability. There is more trouble if their foreign borrowing has gone unhedged.

This calls for some perspective. The rupee has tumbled a good 10% in the last two months alone after the US Fed hinted at rolling back its stimulus. Predictably enough, India saw massive capital outflows in June.

Bad loans are also making life difficult for the Indian banking industry, which have spiked to alarming proportions in the last one year as bleak economic prospects severely hurt profit growth. So much so that many loans, especially in iron and steel, power and infrastructure sectors, are getting restructured.

“If the rupee continues to be volatile or depreciates further, that could impact repayment ability of bank borrowers, and to that extent, there could be pressure on non-performing loans,” said Ananda Bhoumik, an analyst with India Ratings & Research.

The rupee uncertainty has forced a rethink at India Ratings, which now sees asset quality pressure to continue till the end of this calender year, against its earlier assessment of some improvement in the second half of the year.

A Deutsche Bank report paints a similar picture, pointing out that large corporates with leveraged balance sheets and high forex debt could feel the pinch. Leverage levels at BSE 500 companies with debt to equity ratio more than 1 have shot up sharply over the past few years, and at the same time, interest cover has steadily declined, Deutsche Bank calculations showed.

The most levered are the power and steel sectors where the risks run deep while the proportion of overseas debt remains high for some of the larger companies, especially in the infrastructure sector, it added.

An emasculated rupee also means further rate cuts get pushed back by the central bank since it widens the current account deficit, thus jacking up inflationary pressures. “While we had expected a continued rate easing cycle, the rupee depreciation has slowed the process,” said Deutsche Bank analyst Manish Karwa. “Although, the growth and inflation dynamics suggests further rate cuts, the pace of rupee depreciation may result in RBI not reducing rates in the near term.”

Repo rate – the rate at which banks borrow from the central bank – currently prints at 7.25%, one of the highest in the world. This despite the fact that it has come down 125 basis points since April last year.

The dilemma could not be starker. High interest rates, on the other hand, will make things tougher for banks and businesses alike, with exchange rate fluctuations choking economic recovery and keeping loan recovery under pressure. To give you a sense, GDP has already faltered to a decade low in the last financial year.

Possibility of stubborn rates wiped off most of the treasury gains of banks in the quarter ending June. Yields on 10-year benchmark, thus, surged 35 basis points in the last month.