The global credit rating agency expects both bad loans and credit costs to rise as forbearance conditions and easy liquidity tighten. The agency has forecast India’s real gross domestic product (GDP) to grow at 11% for the next fiscal year.

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Fitch believes that state-run banks are more vulnerable than private banks, given their involvement in victim assistance measures, while their profits and capital reserves are low.

The rating agency expects a high risk of a prolonged deterioration in asset quality with increased pressure on retail lending and distressed loans of small and medium-sized businesses. As of December 31, 2020, the aggregate ratio of bad debts, excluding stressed debts suspended, restructured debts and debts overdue for 60 days, stood at 7.2% compared to 8.5% as of March 31, 2020.

Fitch warned that the average contingency reserves of 0.7% of loans are insufficient to absorb the increased stress, although private banks are well above average. Private banks are better positioned to exploit growth opportunities in 2021, as their higher contingency reserves provide better earnings and greater resilience of capital, he said. The average buffer for state banks between pre-provision earnings and credit costs is only 160 basis points (bps) compared to 340 bps for private banks, he said.

State-owned banks have limited basic capital reserves in the event of further stress on assets, which is unlikely to be corrected just through planned capital injections by the Union government of $ 5.5 billion in fiscal years 2021 and 2022, Fitch said.

The rating agency also said the SME sector faced a litmus test in FY22 as short-term credit support extended in FY21, “which in our opinion , deferred recognition of stress, must be refinanced “.