Keeping the Economy Funded

What is the issue?

RBI has raised the repo rate by 25 bps in order to rein inflation.
While controlling inflation is important, it is also vital to ensure sufficient funds to aid businesses to capitalise on projected economic uptick in FY2019.

What is RBI’s inflation outlook?

Projections - RBI looks confident of the growth prospects and has estimated the FY18-19 growth to be 7.4% (FY 2017-18 level was only 6.6%)
Notably, it has sighted improved “Foreign Direct Investment” (FDI) flow and pick-up in services and manufacturing growth as reasons for optimism.
Hence, in line with the projection in its June review, RBI in its recent review again revised its 2H FY19 inflation forecast upwards by 10 bps to 4.8%.
Actions - RBI’s “Monetary Policy Committee” (MPC) has also raised the repo rate by 25 basis points (bps) for the second time in a row.
This has reiterated RBI’s position as an inflation warrior by sticking to the path of maintaining the 4+ 2% inflation target.
Clearly, it is watchful of inflationary pressures like firming household expectations, monsoon spread, increase in crop MSP and fiscal risks.

What are the challenges to reap the projected economic potential?

The latest FICCI survey shows that capacity utilisation levels are in the 75-80% range for sectors such as auto, chemicals, electronics, leather and footwear, machine tools, metals, paper products and textiles.
Considering this, the funding pattern calls for change – funds has to now move away from working capital loans and cater to capacity enhancement.
Hence, while increase in the cost of funds (due to 25 bps raise by RBI) is being debated, the real issues will be fund availability for capacity enhancement.
This can be ushered in only through a conscious policy push as the Indian banking sector is in a deep mess.

What is the scenario in India’s banking sector?

Public sector banks (PSBs) that comprise 70% of the total banking system, hamstrung by poor balance-sheets, are yielding space to private players.
The government and the RBI have leaned heavily in favour of the insolvency bankruptcy code (IBC) to resolve the NPA problem.
Also, the RBI has put 11 PSBs in the prompt corrective action (PCA) framework list and reportedly six more are likely to be added to this list.
RBI’s recent “Financial Stability Report” (FSR) estimates that the gross NPA ratio (bad loans as a percentage of total loans) will reach 12.2% by March 2019.
While would be the highest since 2000, a further warning bell is that FSR states that this could worsen further if macro-economic conditions deteriorate.
More significantly, for PSBs the gross NPA ratio may increase from 15.6% in March 2018 to 17.3% by March 2019 - indicating severe stress.
In this context, private banks will have to do the heavy lifting in meeting the credit needs of an economy which is beginning to recover.

What is the way ahead?

India’s investment cycle is poised for a cyclical upswing from FY19, after years of sub-par performance.
In this context, it is important to incentivising and nurturing sectors in need of funds before the cost of funds begins to bite.
Notably, this is all the more significant considering the global headwinds, which looks risky due to rising political and trade tensions, and currency wars.

Quick Facts:

What is “Prompt Corrective Action”?

To ensure that banks don't go bust, RBI has put in place some trigger points to assess, monitor, control and take corrective actions on banks which are weak.
The process or mechanism under which such actions are taken is known as Prompt Corrective Action (PCA).

What is “Financial Stability Report”?

“Financial Stability Report” (FSR) is released by the RBI.
It reflects the overall assessment of the stability of India’s financial system and its resilience to risks emanating from global and domestic factors.
The Report also discusses issues relating to developments and regulation of the financial sector.

Source: Business Line