The policy rate hikes to curb inflation in many G-20 emerging markets, including India, and will improve banks’ margins. However,  a more rapid acceleration of inflation would necessitate higher loan-loss provisions, erasing margin gains, Moody’s Investors Service had said in a report.

The Moody’s report focuses on banks in the ten G-20 emerging markets: Argentina, Brazil, China, India, Indonesia, Mexico, Russia, Saudi Arabia, South Africa and Turkey.

“Now that most central banks have tightened monetary policy to curb inflation, we expect inflation to abate in all ten emerging markets countries in 2023, helping contain asset risks for banks,” said Eugene Tarzimanov, VP-Senior Credit Officer, Moody’s.

Eugene noted that if inflation rates spike steeply and result in sharp increases in debt-servicing costs for borrowers, banks would have to increase their loan-loss provisions outweighing margin gains, which would be credit negative.

Turkey, the worst hit

Among the ten G-20 emerging markets, Turkey has been facing the steepest inflation, which hit 73 per cent in May 2022, followed by 61 per cent for Argentina, per the report.

Rising inflation rates are mainly because of supply constraints, increases in the prices of commodities and currency pressures.

“Orderly, gradual increases in interest rates will improve banking profits in most emerging market banking systems.

“As a result, Moody’s expects banks in India, Saudi Arabia and South Africa to post comparatively larger increases in margins in 2022-2023,” the report said.

The report assessed that banks’ credit costs also increase when inflation accelerates. An acceleration of inflation has also historically led to increases in credit costs in seven of the 10 systems.

Moody’s expects banks in Russia and Turkey to post larger increases in credit costs in 2022-2023.

In a scenario where inflation accelerates materially and leads to significant rate hikes, credit costs will also rise in Argentina, South Africa and Brazil, the agency said.

Asset risks for banks would outweigh margin benefits if inflation rises more sharply.

An acceleration in inflation beyond Moody’s expectation would lead to higher credit costs that will outweigh the benefits of gains in margins.

In this scenario, Moody’s said the profitability of Brazilian and Turkish banks will likely deteriorate more significantly than in other markets.