Indian Holiday Season May Be Muted This Time

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Summary

Recent data suggest the Indian corporate sector is not in shape to invest.

Poor credit growth and stretched corporate balance sheets may continue to create problems for Indian banks.

Going forward, non-banking financial companies may have an edge over banks in India.

Recently, for the first time in a decade, bank credit to the industrial sector declined in India, a significant change from a decent double-digits type of growth seen just a couple of years ago. Similar weakness also was reiterated by the latest reading on IIP (index of industrial production). In the meantime, IMF came out with its Financial Stability Report and once again raised the problem of high indebtedness of the Indian corporate sector. This growing disconnect, highlighted by these three different data points, between policy and impact, with RBI cutting repo rates while the deceleration in credit growth rate continuing, has larger ramifications for the Indian banking sector, but not yet reflected in the banking stocks.

Industry that does not want more loans

As the chart above shows, the bank loan growth that spiked a few quarters ago has reversed, but more importantly, credit growth to the industrial sector, one of the major indicators of industrial expansion, turned negative. This is far off from the 2000-14 timeframe when bank credit growth averaged around 1.6 times GDP growth. Interestingly, this poor credit growth is when RBI has cut the repo rate by 1.75% over the last six quarters.

The recent reading on IIP was also weak, highlighting the weakness in India's factory output. Within the index, the manufacturing sector that represents 75% of the IIP contracted, hardly an encouraging sign ahead of holiday season.

Improvement may take a while

Looking at the excess capacity and health of corporate balance sheet there is not much to suggest that the situation may improve anytime soon.

Source: RBI

Capacity utilization continues to languish around the 71-72% range, explaining the contraction seen in other data points and hardly enough to warrant new capacity anytime soon. Indeed, more than 78% of the respondents in the RBI survey talked about having adequate capacity to meet demand over next six months and more than 14% having more than adequate capacity to meet any sales spikes.

Image Source: Bloomberg Quint

Another major challenge for the corporate as well as Indian banks is the growing debt on the books of Indian businesses. IMF in its latest GFSR highlighted the risks associated with increasing non-performing loans of Indian banks. Indeed, 13 out of 20 banks with poor NPA ratios are from India, but more importantly, as the chart above shows, the interest coverage ratio of Indian corporate is the second-lowest among emerging economies.

The obvious question that arises after all this is, how will it help arrest the all-important inflation problem in India? The answer is not as much as one may want to see. The reason is that one of the biggest causes of inflationary pressure in India is the supply-side issues in the food sector and looking at more than 9% decline in the bank credit to the food processing sector over last one year the solution to the food inflation may take awhile.

Ramification for the Indian financial sector

The problem from the Indian banking sector is two fold - less demand for credit and slower resolution of the NPA problem. The makeup of indices, including iShares MSCI India (INDA), is such that financials, including banks, constitute a significant chunk, almost 21-22% of the iShares MSCI India index.

Of course, much of the NPA problem is concentrated in the public sector banks, but for a while now, major private banks, including MSCI India constituents like HDFC (NYSE:HDB) and ICICI (NYSE:IBN), were successfully monetizing the market share gains due to problems at public sector banks, but now that growth in consumer debt is expected to drive the next leg of growth, NBFCs, including MSCI India constituents like Bajaj Finance and LIC Housing Finance, stand a much better chance of leading the wave.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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