After rating agencies, now RBI sounds caution on economy
Rajiv Bhuva June 29, 2012The'foreword of RBI's financial stability report actually set the tone for likely takeaways in its sixth report on the health of the economy. The foreword says, "The dictum for central bankers used to be akin to how mothers, across cultures and across time, have admonished their children: 'If you can't say anything nice, don't say it at all.'"
"That dictum is no longer valid," said RBI. Today central banks and regulators have to bear the responsibility of striking the right balance between presenting a candid and accurate picture and not causing unnecessary alarm. That is what the RBI has done in its 83-page comprehensive report.
First, the good news; there has been only a marginal increase in risks to the country's financial stability. "Threats to stability are posed by the global sovereign debt problem and risk aversion, domestic fiscal position, widening current account deficit and structural aspects of food inflation," said the RBI report. The only positive for the domestic economy could come from falling international crude oil prices and a normal monsoon. And Indian banks' soundness indicators remained robust, although the pressures on asset quality persisted.
The report says that the current trend of the country's falling GDP reflects the experience of similar emerging and developed economies, especially the BRICS countries. But the big difference, however, is being deceleration across all the three segments of the Indian economy - agriculture, services and industries.
"The downside risks to growth may persist given the headwinds from the global economy and moderation in private and government consumption and investment demand," RBI cautioned.
Today, the gross domestic savings rate has declined from 33.8 per cent in 2009-10 to 32.3 per cent in 2010-11 while the gross capital formation rate declined from 36.6 per cent to 35.1 per cent. Corporate pipeline investment has shrunk and new investment remains subdued, affected by domestic and global growth outlook, higher interest rates and rising input prices.
The fiscal risks, an area of concern, remain elevated, given that both fiscal and primary deficits have increased during 2011-12. RBI highlighted that recent trends in terms of an elevated ratio of revenue deficit to gross fiscal deficit and the increasing proportion of revenue expenditure relative to capital outlays are also disquieting. "Gross financing needs of the government remain high with consequent impact on private investment and growth," RBI warned. Increased market borrowing by the government has crowded out private investment, which has implications for growth and poses challenges for monetary management.
The uncertain global situation, rising risk aversion and slowing capital inflows, largely resulting from the Euro-area sovereign debt problem, are impacting the emerging and developed economies. The worrying factors for India are the external sector vulnerability indicators, which point to increased risks because of falling exports and imports remaining high on the back of sustained demand for gold and crude oil. There has been a deterioration in the key external sector vulnerability indicators like imports reserve cover, the ratio of short-term debt to total external debt, the ratio of foreign exchange reserves to total debt and the debt servicing ratio. The import cover declined to 8.5 months in September 2011 from 9.6 months at end-March 2011. The ratio of short-term debt to the foreign exchange reserves was 21.3 per cent at end-March 2011 and it increased to 23 per cent. The ratio of volatile capital flows (defined to include cumulative portfolio inflows and short-term debt) to the reserves increased from 67.3 per cent as at end-March 2011 to 68.3 per cent as at end-September 2011.
"They pose challenges to India's growth and balance of payments outlook," says RBI. Today, the net international investment position of the country has worsened with rising short-term debt relative to total external debt. Falling international oil prices, if sustained, in RBI's opinion, will help moderate external sector risks. "But, domestic factors viz., a fast depreciating exchange rate, reduced capital inflows and the risk of downgrade of the sovereign rating of the country continue to pose challenges for the financing of the deficit," RBI added. The danger continues with the deleveraging process which is underway amongst European banks. That has had some impact on the cost of borrowing for Indian firms and banks. "A change in the current external rating of the country could have 'cliff effects', impacting both the availability and the cost of foreign currency borrowing for Indian banks and firms," said RBI.
And finally the banking sector, the backbone of the economy, where vulnerabilities exhibited a mixed trend at the end of March 2012. While soundness and profitability indicators showed some improvement over the position as st end September 2011, the same exhibited a deterioration vis-a-vis their position in March 2011.
"Strains in asset quality intensified," said RBI. "The liquidity deficit added to the stress in the banking sector." Furthermore, RBI's Banking Stability Indicator, as at end March 2012, pointed to deterioration in the stability of the banking sector, compared with its position in September 2011. "A forecast of the indicator for the next two quarters surmised that the risks to the banking sector are likely to remain elevated in the near term," said RBI. "Asset quality concerns persist as the growth in non-performing assets (NPAs) accelerated and continued to outpace credit growth," said RBI. NPAs grew at 43.9 per cent as at end March 2012, far outpacing credit growth of 16.3 per cent. "The divergence in growth rate of credit and NPAs has widened in the recent period, which could put further pressure on asset quality in the near term," RBI warned.
To add to this, RBI mentioned that respondents to RBI's Systemic Risk Survey also identified asset quality as one of the critical risks faced by the Indian banking sector. The banking system's gross NPA ratio increased to 2.9 per cent as at end March 2012, as against 2.4 per cent as at end March 2011 and 2.8 per cent as at end September 2011. Net NPA ratio stood at 1.3 per cent as at end March 2012, as against 0.9 per cent as at end March 2011 and 1.2 per cent as at end September 2011. "The ratio of NPAs (net of provisions) to capital also falls short when benchmarked against the peer economies," said RBI.
The slippage ratio - fresh accretion of NPAs during the year as a percentage of total standard assets at the beginning of the year - increased to 2.1 per cent as at end March 2012 from 1.6 per cent at March 2011 and 1.9 per cent at September 2011. "The ratio of slippages plus restructured standard advances to recoveries (excluding upgradations) also exhibited an increasing trend underscoring the concerns with respect to asset quality and the need for proactive management of NPAs by banks," RBI advised.
RBI, by all means, has raised the caution flag for the stability of India's financial sector at a time when macro-economic factors are a matter of worry, shadowed by the gloom prevailing in the larger economies across the globe.