Moody’s Investor Service upgraded the outlook on Indian local currency debt on Tuesday, December 15, 2009. However, the ratings remained unchanged. The outlook was turned from ‘stable’ to ‘positive’ at a rating of Ba2 (non-investment grade), in the wake of higher than expected GDP growth rate of 7.9% in the quarter ended September, 2009.

The improvement in the outlook is based upon the relative strength of the Indian economy, where the cyclic trends represent strength and sustainability. Government initiatives and regulatory measures have the strongest growth drivers in the economic recovery in India. This has translated into the Government debt holdings being viewed as more favorable for the banks. According to Moody’s, the Indian policy makers so far have been successful in formulating and implementing counter-cyclic policies, which is also likely to facilitate an easier exit strategy for the Government.

According to Moody’s sovereign analyst for India Mr. Aninda Mitra, “….the Indian economy has demonstrated its resilience to the global crisis and is expected to resume a high growth path with its underlying credit metrics relatively intact.” In addition, Moody’s revised the ratings on Indian banks’ foreign currency deposits from Ba1 to Ba2 to factor in, the Indian economy’s strong external position. As per the agency, the upgrade in the local currency outlook is also an indicator of a possible increase in the ratings over the next 12 months or so.

The roots of the Indian banking industry go back to the 18th century when the first bank was established here. In 1969, the trend of nationalization of banks started and the economic reform of 1991 saw the privatization of the industry.

The sector is now mainly divided into public or private sector banks, regional banks, rural and cooperative banks. Since the scope of business is very high, foreign banks have also made their base in the country and extended their operations through robust branch network. The branches vary from retail banks, loan divisions (taking care of home loans, personal loans etc), and corporate banks (for bigger clients like other industry players).

The Reserve Bank of India is the central bank which acts as a regulator for all the other banks in India. The RBI has the sole authority to grant license, control credits, thereby functioning as a banker for all banks coming under it. The other noteworthy Indian banks are the State Bank of India which is a public sector bank, ICICI which is a private bank, IDBI, and HDFC bank. The list of foreign banks includes HSBC, American Express, ABN Amro Bank, Standard Chartered Bank etc. The presence of such a large banking network shows the pace of reforms set forth by the Indian govt. over the last decade in financial market, banking and non-banking sectors and their development.

On November 25, 2009, the Dubai Government made a declaration that jolted the already ailing world economy. In a shocking announcement, the Government stated that, Limitless and Nakheel, the flagship property companies of the State-owned conglomerate Dubai World, were likely to turn insolvent. The Government asked for a moratorium until May 30, 2010 or further, from its creditors. The disaster spelt the unconfirmed figures of over USD 60 billion in locked credits and over 10,500 laid-off employees worldwide, for Dubai World.

As a result, the European bourses fell by more than 3%, the Asian markets crashed, and SENSEX in particular lost 390 points in a day. There are various causes of worry. A large number of Indian workers migrate to Dubai in the search of better salaries, every year. Millions of Indian households depend on these remittances. Today, Indians constitute almost 42.3% of Dubai’s total population. The exposure of Indian banks in Dubai’s markets is estimated between Rs. 5,000 and 6,000 crores. Various Indian real estate developers, such as BSEL Infra, Nagarjuna Constructions, Omaxe, and Larsen & Tubro, had ventured into Dubai and are likely to be affected badly.

However, the industry watchers and experts say that the impact of the problem is being overstated. The Finance Minister of India has remarked, “… there is no need to press the panic button.” Meanwhile, Navin Kapoor, a board member of the Indian Business Professional Council in Dubai, said that there would only be a minor impact, if any, on India. Robert B Zoellick, the World Bank President also reiterated the same point.

Even as economists of the world look towards India optimistically, statistics say that all is not well. The credit outlook for most Indian banks remains negative after the changes made in January earlier this year. Though the fundamental credit outlook was stable, the economic conditions still remain challenging and the number of problem loans or ‘bad’ loans still continues to be on the rise. Of course, the result of all this is an adverse effect on the quality of assets.

It has been estimated that even in the next twelve to eighteen months, things are not going to change for the better. There are no optimistic projections for the next year or two. The public sector banks, which make up the majority of the banking systems and assets, continue to hold a strong front. The concern for the deteriorating asset quality still looms large.