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