India’s economic recovery reduces the risk of a sharp deterioration in public sector banks’ mildly improving asset quality, according to Moody’s Investors Service.

Moody’s said that the Indian government's budgetary allocation to recapitalise public sector banks will be insufficient to absorb unexpected shocks and support credit growth. The government plans to infuse 200 bln rupees in equity capital into public sector banks in 2021-22 (Apr-Mar), on top of the 200 bln rupees budgeted in the current financial year. According to the rating agency, various measures by the government to support borrowers have helped curb growth in public sector banks' nonperforming loans, as reflected in the volume of restructured loans, which is not as large as anticipated.

Additionally, the likely economic recovery in 2021 may reduce the likelihood of a sharp deterioration in the asset quality of public sector banks. Moody's also said that asset quality of the five largest rated public sector banks--State Bank of India, Bank of Baroda, Punjab National Bank, Canara Bank, and Union Bank of India- -improved mildly in Apr-Dec despite economic contraction exacerbated by the COVID-19 pandemic.

The gross bad loan ratio of these banks declined by an average of about 100 basis points as of December 31 from a year earlier, even after including loans that have become delinquent, which have not formally been classified as non-performing because of a pending case in the Supreme Court. However, the agency said that India's public sector banks will continue to face capital shortages, as their profitability remains weak amid high credit costs, leaving them vulnerable to any unexpected stress. It added that fund infusion will help meet capital norms but it will not boost credit growth in such banks.

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