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Budget 2009-10 reaffirms capital support to government-owned banks, asset quality concerns remain, says Fitch

According to Fitch Ratings, India's FY10 Budget has reaffirmed the government's commitment for providing capital to government-owned banks and may help them match asset liability tenors for long tenor loans. However, the agency feels that the proposals outlined are unlikely to stem the asset quality pressures banks face and may adversely impact margins as cost of funds could rise.

The budget rules out privatization of government-owned banks and reaffirms the government's commitment to infuse capital into these banks. However, it does not clearly specify the mode and timeline of such capital infusions. Fitch notes that recent capital infusions have been through subscription to hybrid capital instruments. While this addresses near term needs, Fitch believes that the need to enhance common equity would be magnified over the medium term for maintaining adequacy and quality of capital.

Over the last 12 months corporate cash flows have been adversely impacted due to demand contraction and the consequent drop in capacity utilization. The proposed increase in government spending, while providing a boost, is unlikely to result in a meaningful improvement in overall demand. The expected rise in the cost of funds will likely put additional stress on the debt servicing capabilities of corporates over the medium term. The extension (until 31 December 2009) and increase in subventions for crop loans (up to INR300,000) may lead to a short-term asset quality improvement, but the sector continues to face significant challenges arising from volatile commodity prices and delayed monsoons. Although budget proposals regarding extension of refinance to infrastructure and micro & small enterprise sectors, concessions to the export sector and the creating of a level playing field for the commercial vehicles sector - due to the levy of service tax on freight movements by rail - could slow the NPL accretion rate in these sectors, it is unlikely to reverse the increasing trend currently prevailing. Thus, Fitch believes that the budgetary measures are unlikely to meaningfully alleviate the asset quality pressures that banks face.

The budget proposals outline a significant enhancement in the government's already large borrowing programme. While bond yields have to an extent factored in higher government borrowing, Fitch believes that yields could rise further due to the additional borrowing being proposed. This could lead to a significant increase in mark-to-market provisions on the available for sale debt securities portfolios of banks, which constitute between 5-10% of assets for some banks. In addition, as seen in the previous interest rate cycle, the expected rise in interest rates could lead to a movement of funds away from lower cost current and saving deposits towards higher cost term deposits. This could be negative for the net interest margins of Indian banks.

The government's decision to make refinancing available for infrastructure and rural housing (which have long tenor financing requirements) would likely make it somewhat easier for banks to match asset liability tenors.

(Source-Fitch Ratings India)

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