Fitch Ratings on Thursday said if the government front-loads a substantial part of the capital injection into State-owned banks, it may revise the sector outlook to stable during FY18 from the current negative outlook.

The revision in the sector outlook is subject to greater clarity on operational details and timelines associated with the recapitalisation exercise.

“Fitch has had a negative sector outlook on Indian banks for many years. But if the government’s October 2017 announcement to inject $32 billion of fresh capital into the State-run banks over the next two years is well executed, it will be significantly credit positive,” the agency said.

The agency observed that it is generally expected that a substantial part of the capital injection will be front-loaded.

Fitch elaborated that the substantial government contribution (around 30 per cent of State-led banks’ equity base) which is to be injected directly by the State is a departure from past practices, and should go a long way in plugging the capital gap amid expectations of more haircuts and subdued earnings. “It (capital injection) will stem the downward pressure on viability ratings (VRs), which have seen several downgrades over the last three to four years, and improve their ability to raise capital on their own, which had been limited so far due to poor health and weak valuations,” the agency said.

The announcement on recapitalisation has already had a sobering effect on banks’ additional tier 1 (AT1) yields and a positive impact on their equity valuations.

Underscoring that the government has indicated that it plans to front-end a significant part of this planned injection, the agency said while the timing is crucial due to the beneficial impact it can have on both the pace of NPL (non-performing loan) resolution — where banks have been hesitant to accept large haircuts due to the potential capital impact — and banks’ ability to raise capital at better valuations.

A protracted downturn, slow resolution of NPL stock and a sharp slowdown in credit growth have pushed the asset-quality cycle longer than envisaged, Fitch said.