Fitch Ratings expects deteriorating asset quality for Indian non-bank financial institutions (NBFIs) in 2022 stemming primarily from micro, small and medium enterprises (MSMEs) and microfinance lending sectors along with property construction finance.

The ratings agency cautioned that the surge in Covid-19 cases in India associated with the Omicron variant may delay the recovery in MSMEs and microfinance lending, adding to asset-quality risks for Indian NBFIs.

In this regard, Fitch referred to the Reserve Bank of India’s Financial Stability Report, published in December 2021, which noted emerging signs of stress among MSMEs as well as microfinance.

Such borrowers generally run on limited cash buffers and capital, and have suffered disproportionately during the pandemic due to their more vulnerable business franchises.

Fitch observed that MSME business activities picked up in the second half of calendar year 2021, but remain below pre-pandemic levels.

“The surge of Omicron cases in January 2022 may disrupt the recovery temporarily. Our assumption is that the scale of disruption associated with the wave will be modest by comparison with India’s initial lockdown in 2020 or the Delta variant wave of 2021, and we currently project real GDP growth in the year ending March 2022 at 8.4 per cent,” the agency said.

Nonetheless, there is likely to be some impact from the Omicron surge as local restrictions are re-introduced. This comes at a time when financial buffers have already been eroded for many small borrowers.

“Recoveries from MSMEs have been sluggish due to slower collateral liquidation during the pandemic. We expect recoveries of property-backed loans in semi-urban areas will continue to be hampered in 2022 by relatively low liquidity in such real-estate markets,” Fitch opined.

State elections

For microfinance, further challenges may stem from upcoming elections in five large States, including Uttar Pradesh (UP).

“Political pressure can often impede loan-recovery actions around election season, and UP is home to a large rural population and microfinance sector. The State accounted for around 8 per cent of outstanding microfinance loans in India at end-September 2021,” the agency said.

Fitch expects stresses in the MSME and microfinance segments to culminate in higher non-performing loans (NPLs), particularly as tightened impairment recognition norms come into effect by March 2022.

“Many lenders with greater exposures in these fields tend to be smaller and reliant on bank funding, and could face funding pressures due to sustained risk-aversion among banks. The severity of further asset-quality deterioration and impairment costs will depend on the pace of economic recovery. We believe the authorities are likely to step in with further forbearance if impairments climb too quickly,” Fitch said.