After Rajan, what next for India’s banks?

BlackRock |05-Aug-2016


Raghuram Rajan’s exit from the Reserve Bank of India may imperil necessary banking reforms, but there are still investment opportunities in the sector.


The confirmation that Raghuram Rajan will step down as governor of the Reserve Bank of India in September was not really a surprise, and it must be hoped that his successor springs no surprises either.

Stability has been a hallmark of Rajan’s time in charge, but it is worth remembering what he inherited. When he became governor in 2013, India was labeled one of the ‘fragile five’ – a quintet of countries with worrying current-account deficits. The reforms ushered through by Rajan turned around India’s economy.

One of Rajan’s most prominent achievements was to tame inflation: it fell to 5.9% last year, from 10.9% in 2013. Rajan has also managed to cut India’s interest rate from 8% to 6.5% over the past two years, stimulating the economy without reigniting inflation. Indeed in the most recent quarter for which official figures are available, the three months ending 31 March 2016, India’s economy grew by 7.9%.

Bank reforms in the balance

Yet, one of the most important tasks begun by Rajan remains unfinished: reforming India’s banks, which was set out as one of Rajan’s five priorities early in his tenure. The greatest problem facing India’s banking sector is dealing with a legacy of bad loans. According to a report released in June by the Reserve Bank of India, non-performing loans ‘rose sharply’ to 7.6% in March 2016, from 5.1% in September 2015, with the Bank adding that in its baseline case, the ratio could jump further to 8.5% by March 2017 – or even 9.3% if the economy deteriorates.

The more consumer-focused banks that we prefer are exposed to the positive growth trends of this thriving country

Such a trend is clearly alarming, but it does not mean that we as investors should ignore India’s banking sector. The country’s young and growing population is still under-banked relative to other emerging economies: a report published by the Reserve Bank of India last year showed that in 2014 just over 50% of Indian adults held an account with a financial institution, compared with almost 70% in other major emerging markets, while only 6% of Indian adults had borrowed from a formal financial institution in the past 12 months, compared with 10% or more in other emerging economies.

Fostering innovation

Encouragingly for investors, India is also taking steps to make it easier for new banks to establish themselves in the country. In May, for example, it revealed a new ‘on tap’ licensing framework, which should foster innovation. Undoubtedly, there will be challenges ahead, but such liberalisation has to be the future of India’s banking sector and we hope the next governor will support this agenda.

In the meantime, as investors, our focus within India’s financial sector is on non-public sector banks. While these public sector banks are the ones most exposed to bad debt, the more consumer-focused banks that we prefer are exposed to the positive growth trends of this thriving country.

Andrew Swan
Managing Director
Andrew Swan, Managing Director, is the Head of Asian Equities for the Fundamental Active Equity division of BlackRock's Active Equity Group.
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This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of 1 August 2016 and may change as subsequent conditions vary.