>INDIA STRATEGY: Peak of NPA cycle still not behind us

We revisit our banking theme “Slippage not the only thing, new risks are emerging, May 2012” to assess the endurance of the rising NPA cycle and conclude that structural (and also cyclical) factors that sustained decline in NPA ratio during 1994-2008 are now receding, leading way for longer and structurally higher GNPA ratios. Inclusive of GNPAs and restructured asset, the stressed assets for the banking system have risen to 9% of total lending or equivalent to GNPA ratio seen during early 2000s. We see the ballooning GNPA cycle rooted to an overleveraged banking system and weak macro conditions. Sustenance of higher elasticity of GNPA/Credit
growth at 3.4x post 2008 and decline in credit growth in response to credit risk concerns will imply GNPA growth sustaining at 40% implying

GNPA/Advance rising to 4-6.5% in the next two years.
Ballooning NPAs rooted to the lack of countercyclical buffer
In our view, the fulcrum of the current NPA upsurge, steeper than in the late 1990s, can be
attributed to overleveraged banking system reflected in renewed weakening of counter
cyclical buffer which reversed the readjustment for the credit boom during FY04-07
instilled by decline in credit growth during FY08-FY10. The deleveraging process was cut
short by the lagged impact of liberal credit restructuring and fiscal & monetary expansion
in FY10. Phases of overleveraged banking is followed by multi-year moderation in credit
growth and cyclical upsurge in GNPA (FY86-FY89, FY97-FY00, FY008-FY10 and FY12).

Rising NPA also reflect weakening in macro conditions
The linkage of the macro economic conditions to the elevated leveraging in the banking
system is embodied in multiple variables including decline in domestic saving rate (public,
household and private), impairment of productivity growth due to persistently high inflation,
commodity prices & revenue deficit and decline potential GDP growth.

Post 2008 inverse GNPA/Credit elasticity has risen sharply
GNPA/Credit elasticity has risen to 18-year peak with six year rolling elasticity rising to (-)
3.1. As current level of GNPA excludes restructured assets, expected moderation in credit
growth will imply further and substantial rise in GNPA going forward.

To read report in detail: INDIA STRATEGY