Though Moody's Investor Service, on Thursday, changed India's outlook to positive from stable, the rating agency also highlighted concerns regarding India's banking sector's asset quality.
While the rating remains optimistic on the outlook for the economy and the government's reform process, it has warned that India's banking system's asset quality, loan loss coverage and capital ratios are relatively weak.
This, according to the rating agency, poses sovereign credit risks because of the banking sector's role in financing growth as well the government's deficits through its purchase of government securities, and the contingent liabilities due to the government's ownership of a major portion of the banking sector.
"In the absence of any improvement in banking system metrics over the coming months, India's sovereign credit profile will remain constrained," it says. However, Moody's believes that the ability of policymakers to strengthen India's sovereign credit profile to a level consistent with a higher rating will only become apparent over the next 12 - 18 months.
Despite Moody's flagging off concerns, banking stocks gained ground on Thursday on account of the revision in rating with the Bank Nifty gaining over 2% in intra-day deals. In comparison, the benchmark indices, the S&P BSE Sensex and the CNX Nifty, moved up around 0.3% each in noon deals.
Punjab National Bank (PNB), Kotak Mahindra Bank, IndusInd Bank, Canara Bank, Bank of Baroda (BoB) and Axis Bank were among the top gainers among the banking stocks that moved up between 2% - 5.5% in intra-day deals.
SLOW ROAD TO RECOVERY
Analysts believe that the concerns highlighted by Moody's are not new and going ahead, the problems in the banking sector will mend. However, they caution that this will be a long drawn process.
Directionally, they suggest, things have started to improve for the banking sector, though the pace of improvement maybe a little slow. Banks' earnings in the Q4FY15 quarter and the next two quarters of FY16 may not be good and the stressed assets should peak in the March'15 quarter. By the end of FY16, the level of stressed assets in the system should be lower than in the previous year.
"It is quite evident from the data the kind of stress there is in the banking system, primarily in the public sector banks (PSB's). But from a forward looking view, the government's reform process should start revising the core sectors like infrastructure, power, metals etc. So, the stress levels in these banks should start coming down from FY16 and FY17 onwards," said Vaibhav Agrawal, vice-president (research - banking) at Angel Broking.
"If we put together power, infrastructure and roads, they in total account for 60 - 70% of the restructured assets. What's left then is textiles and chemical sectors that are export - oriented and have stress. As regards agriculture, there are well defined systems in place that address issues like erratic monsoon or crop failure where banks need to deal with such accounts,"" he adds.
Ankit Ladhani, an analyst tracking the sector with Karvy Stock Broking also expects asset quality concerns for the banking sector are expected to continue in Q4FY15 results as well. The performance of private banks, however, is expected to be better than that of PSBs though they are also expected to report higher slippages and restructuring. He maintains a buy rating on Axis Bank, DCB Bank, Federal Bank, ICICI Bank and YES Bank; and a hold rating on HDFC Bank.
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