Should Indian Banks Be Worried of a Contagion?

As we write this note, there is an element  of fear across global economies and more so in the financial sector. Aggressive rate increases and tightening of liquidity has begun to take it’s toll on various banks especially in the US and Europe. The case of SVB Bank, Signature Bank, etc. is a clear case of improper banking practices and absence of an effective risk control mechanism. Credit Suisse has been on the sick bed for a number of years. Their problem has only been aggravated due to the liquidity tightening. These “fallen angels” have now either stopped their operations or merged with other banks. The quick action by the Central banks of these countries has prevented a possible run on more banks and an enhancement of trouble in their banking system. If the western Central Banks continue to tighten, expect more skeletons dropping off their cupboards! It is paradoxical to see the proponents of risk control and fair banking practices themselves being caught in the whirlpool.

So, what are the risks of a global financial contagion? It is always possible that the fire may spread out. But quick action by the central banks seems to have brought things under control, atleast on the surface. One only hopes that the central banks mellow down on their hawkish monetary stance. To our mind the problems in the financial system of these countries is in itself deflationary and therefore there is a strong case for them to dilute their stance. A look at the state of affairs in other countries, does not indicate a contagion so far.  If one takes a look at the state of affairs in Asia. Things seem to be in control. While South Asia has some trouble spots, East Asia seems to be doing okay economically and also financially. Fall in crude prices and in other commodities has taken the pressure off. Inflation is under control and most central banks in the region have been conservative and proactive enough to protect themselves from mishaps.

Several of our clients and readers have inquired about the impact on our banks. We believe that Indian financial system is among the most robust in the world. The clean up project that was undertaken about 7 years ago and which is now almost completed has ensured clean balance sheets of the Indian banks and therefore their ability to absorb any shocks is significantly higher. The regulator has enhanced the risk control mechanism to reduce chances of recurrence of a similar scenario. Moreoever, the credit cycle in India has begun the uptick only since last year and therefore probabilities of any deterioration in their loan books are low. Capital intensive sectors like commodities, infrastructure, real estate, etc have mixed requirements of funds, so far. Besides there are more number of ways of funding them, rather than just debt. India has always been marginally integrated into the global trade. Our exports are miniscule globally while imports are higher but are within tolerable limits. The inflow and outflow of funds from our system is well under control with numerous checks and balances by our central bank. The large foreign exchange reserves and periodic intervention by the central bank has ensured orderly depreciation of our currency. The fall in crude prices, to which Indian is highly sensitive, has been comforting. The rating agencies and the multi-lateral agencies therefore, seem happy with the overall shape of our economy. As mentioned above, the problems in the developed countries and modest growth rates in China coupled with geopolitical issues, could ensure that inflation could stay subdued. That would embolden our central bank to change their stance to a more conducive one.

While we are positive on our economy, we cannot wish away the risks lurking around us. The biggest risk is the Ukraine War. If it does not stop and other nations get sucked into it, that could mean significant disturbance in the global world order. Monsoon is another factor as always which could impact our country. There is a risk of El Nino. We have had 4 consecutive good monsoons, which in itself is unusual. Therefore, the probability of an unsatisfactory monsoon season this year, increases. Global warming and deforestation are aggravating water scarcity in several parts of the world. India too has it’s share of water woes in several cities. We have elections in 2024. Political stability is a pre-requisite for stable economic growth. If the verdict is fractured, that could impact the growth and our ratings. There are a slew of other risks that could be outlined. The surge in gold prices is reflective of the rising insecurity globally. We currently are on a firm footing, but, considering the world that we live in, it pays to be conservative and view risk and return evenly, while elongating the investment horizon.

Happy Investing!

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