By Ashvin Parekh, Managing Partner, Ashvin Parekh Advisory Services LLP
Recent geopolitical tensions, the US’s major tariff impositions, and India’s proactive response—both through trade diversification and new bilateral arrangements—and the recent goods and services tax (GST) changes are reshaping the opportunities and challenges faced by the Indian banking, financial services, and insurance (BFSI) sector. This article discusses the impacts with sector-specific insights.
The banking sector has fared well in the last couple of years in terms of both asset performance and its treasury operations. Against the backdrop of the developments mentioned above, it will have domestic growth and benefit from the Indian economy’s resilience and robust domestic demand. It will be partly insulated from direct export stocks caused by new tariffs. The recent GST reforms will boost consumption and therefore the economy’s credit needs. The second major opportunity will be digitalisation and financial innovation, seen via the rapid adoption of digital finance, United Payments Interface expansion, and fintech collaborations.
The new bilateral agreements will also drive international trade finance opportunities with new international markets, which could be the third major opportunity. Diversified international partnerships and India’s pivot toward Association of Southeast Asian Nations, Latin America, and Africa will reduce over-dependence on US and European Union trade, providing banks with new relationships and infrastructure opportunities. The fourth factor will be by way of regulatory support and reforms. The Reserve Bank of India is expected to induce liquidity and lower interest rates, fostering credit growth and potentially reducing borrowing cost for businesses and consumers. Policymakers are insisting that the GST benefits are passed on to the customers, which will lead to consumption and credit flow, particularly in the housing finance and vehicle loans segments.
However, some challenges persist, such as export-linked loan risks. Banks with a heavy exposure to export-oriented sectors (gems, textiles, chemicals, IT) are at risk of asset quality deterioration as US tariffs lead to shrinking exports and job losses. The second major challenge will be currency and capital flow volatility. Tariffs and a weaker Indian rupee may increase forex and capital flow volatility, challenging banks’ treasury management. For forex, the major challenge will be the exchange rate volatility. Persistent depreciation impacts banks holding large FX positions. The balance-of-payments strain will cause an increase in hedging costs. The third major challenge will be that of deposit competition—elevated deposit interest rates will persist as banks compete for stable funding, potentially squeezing margins. Lastly, micro, small, and medium enterprises in the affected sectors may face a liquidity crunch, raising the possibility of non-performing asset risks for lenders, necessitating cautious underwriting and possible policy support.
As for asset management and mutual fund, the sector has been growing at a brisk pace, and the membership of retail investors is increasing by leaps and bounds. Tariff impositions and the recent rate cut by the Federal Reserve will have a direct impact on the investment flows in and out of Indian markets. The Fed’s rate cut can have a positive impact on the markets as lower US yields reduce the incentive for investors to keep assets in the US, encouraging inflows into emerging markets. The first major area of both opportunity and challenge is the volatility and flight to quality. Funds will look for more stable assets, with an increased preference for domestic and performing sectors such as financial services, healthcare, and industrials. The second impact will be on selective sectoral opportunities. Fund managers will scout for assets in counters minimally impacted by tariff impositions. Here, both managers and investors will look at exchange traded funds, particularly the gold and silver. However, considering the Indian economy’s robust performance, long-term flows, particularly due to strong domestic retail participation and systematic investment plan flows, act as strong stabilisers. From the GST 2.0 reforms perspective, there is no significant change in the cost structure for unit holders or mutual fund companies.
Tariff impositions will perhaps have very little impact on the insurance sector, but that is not the case as far as GST reforms are concerned. The changes exempt GST on premia paid by policyholders for some products in life insurance and retail health insurance covers. This is apparently a welcome move as it may imply lower costs for the policyholder at the cost of the government exchequer to the extent of around Rs 6,000 crore annually for life products and around `7,000 crore annually for health insurance. If we analyse this reform, we may see that the implication of rate revision and exemptions offered to the insurance industry could have been studied before making such changes.
The government has a noble vision of ensuring that all Indians are covered under insurance by 2047. For this vision, policymakers recognise that the industry will have to augment the capacity or capital several times. This is to be done by encouraging the private sector domestic players as well as their strategic or financial foreign investors. The foreign direct investment reform of up to 100% foreign equity is a major step towards this. Large foreign capital can potentially or hypothetically flow into the economy. Unfortunately, the actual traction or inflow is insignificant.
Reduced interest from investors could be due to changes in regulations in the last couple of years. The reduction of the surrendering period for life policies to a year is one such example. The GST 2.0 changes will significantly reduce the returns and therefore investors’ interest, both domestic as well as overseas. While the exemption of GST on life and health insurance will reduce the cover cost to policyholders, companies will be denied input credit for GST paid for acquisition and management expenses. The financial implications to the life insurance companies are expected to be around Rs 13,000 crore annually and around `2,500 crore annually to health insurance companies. This may be an unintended consequence, and the government may perhaps examine the implication afresh.
The tariff impositions will impact the BFSI sector, offering new opportunities and challenges. The government’s response in term of trade diversification and direct and indirect tax reforms will provide some additional cushion. The macro impact looks favourable to the sector, but players will realign their strategies to ensure the quality of their books.