Cautioning that global financial stability risks have risen since last October and are shifting from advanced economies to emerging markets, the International Monetary Fund (IMF) on Wednesday also warned that a significant share of debt in emerging markets including India is owed by firms with relatively constrained repayment capacity.
The repayment capacity of these Indian companies is constrained in terms of interest-coverage ratios (defined as the ratio of earnings before interest, taxes, depreciation, and amortization to interest expenses), the IMF’s Global Financial Stability Report (GFSR) showed.
“Banks burdened with non-performing loans have less incentives to provide credit. They are also less profitable. This affects credit supply and therefore this problem requires the authorities’ attention,” said José Viñals, Financial Counsellor and Director of the Monetary and Capital Markets Department at the IMF.
Among the major threats to global financial stability flagged off by the IMF include the possibility of investors being surprised by the timing of the rate hike by the US Federal Reserve and the consequent market tensions and liquidity risks. Risks also include the ramifications of high non-performing loans in the Euro area, losses incurred by oil producing economies due to the oil price fall, emerging market companies and governments with huge dollar borrowings (facing difficulties due to dollar appreciation and their earnings being mostly in local currencies). Other challenges include the spillover of the adverse impact of the plunging property prices in China and the resulting impact on its financial sector.
On the rise in bad loans in India, the rating agency ICRA forecast had showed that the non-performing assets ratio of Indian banks could jump from 4.5% in December 2014 to as high as 5.7% by March 2016. The RBI governor Raghuram Rajan had recently said “in the short term there was a need to clean up bad loans and then restructure other stressed loans so as to put the economy back on the track.” He had also made a case for strengthening the capital base of the banks and stressed the importance of better governance and management expertise as well as ownership consolidation.
In its assessment of financial stability of emerging market banks, the IMF said India has a large share of corporate debt-at-risk, or the share of corporate debt held by the “weak firms”.
It said loss-absorbing buffers appear particularly low in India and deterioration in loan quality could threaten capital levels. “System-wide Tier 1 ratios for most emerging market economies are above 10%. However, the countries with the lowest ratios are China, India, and Russia, which account for about 70% of the aggregate banking system assets in this sample of banks,” the report said. Last month, the IMF observed that deteriorating corporate financial positions and worsening bank asset quality in India could weigh on its financial sector soundness. It had asked Indian authorities to further strengthen prudential regulation for banks’ asset quality classification, address concentration risks, augment capital buffers, improve corporate governance at public sector banks and strengthen the insolvency framework.