Fitch Ratings says that India's FY10 Budget has reaffirmed the government's commitment for providing capital to government-owned banks and may help them match asset liability tenors for long tenor loans.

However, the agency feels that the proposals outlined are unlikely to stem the asset quality pressures banks face and may adversely impact margins as cost of funds could rise.

The budget rules out privatisation of government-owned banks and reaffirms the government's commitment to infuse capital into these banks.

However, it does not clearly specify the mode and timeline of such capital infusions. Fitch said that recent capital infusions have been through subscription to hybrid capital instruments. While this addresses near term needs, the need to enhance common equity would be magnified over the medium term for maintaining adequacy and quality of capital.

Over the last 12 months corporate cash flows have been adversely impacted due to demand contraction and the consequent drop in capacity utilization. The proposed increase in government spending, while providing a boost, is unlikely to result in a meaningful improvement in overall demand. The expected rise in the cost of funds will likely put additional stress on the debt servicing capabilities of corporates over the medium term.

The extension (until 31 December 2009) and increase in subventions for crop loans (up to Rs300,000) may lead to a short-term asset quality improvement, but the sector continues to face significant challenges arising from volatile commodity prices and delayed monsoons.

Although budget proposals regarding extension of refinance to infrastructure and micro and small enterprise sectors, concessions to the export sector and the creating of a level playing field for the commercial vehicles sector - due to the levy of service tax on freight movements by rail - could slow the NPL accretion rate in these sectors, it is unlikely to reverse the increasing trend currently prevailing.

Thus, Fitch believes that the budgetary measures are unlikely to meaningfully alleviate the asset quality pressures that banks face.