RBI’s Financial Stability Report is another commentary on the state of the economy which goes beyond the statements and speeches made by various government and RBI officials. While the report is evidently focusing on the stability of the financial sector, it necessarily takes us through the macroeconomic scenario and then juxtaposes the state of the financial sector along with the macro picture. In the process, it brings out additional concerns that are latent in the system, which go beyond the regular pessimistic views on GDP growth and inflation.
These reports are a new addition to the economic literature and are in line with what other central banks do in other countries and the IMF at a global level. The report actually does not say anything that we were not aware of, but by putting these otherwise random thoughts on paper and highlighting the possible repercussions, RBI actually does ask us to stop and think about the way ahead. Two areas stand out.
The major takeaway on the economic front is an overt acceptance that things are not right today and that the downside risks are far too many. GDP growth is precariously placed, as are industrial growth and investment. Should one take it that there could be a downward revision in RBI’s estimates of GDP for the year from 7%? Here, RBI has not really provided numbers.
Again, it talks of inflation being a concern and the belief that it will remain elevated. Does this mean that there is a signal again that RBI will not be in a hurry to lower interest rates? One is not too sure here about whether it is a strong thought to be chewed on or whether it will be the underlying conviction when the July policy is announced. There is an acceptance that the opinion of credit rating agencies on India’s sovereign rating does matter and the impact is negative. Also, the dollar will be volatile. Are we to take it that RBI will have little to do on this front once all the policy options are exhausted?
At another stage, it is quite harsh on the fiscal side and quite realistically casts a doubt on whether the fiscal deficit target will be attained, given all the current pressures around. This sounds contrary to what the ministry of finance has averred, that the deficit will not be exceeded.
Therefore, at the macro level, one gets a feeling that RBI is saying things that are different from the government, where the stance is that while problems are there, we are not going to do too badly.
The other area where RBI has been vocal is the financial system. Here, it does blow hot and cold on the state of the system. It does say that the banking system is very well capitalised and there is no worry, though going ahead, raising capital will be a challenge and it will entail a cost. It is more definite and unequivocal on the quality of assets part, where it has voiced concerns on the rising NPAs and the quantum of restructured assets, which will come back to haunt us later.
Interestingly, the highest level of NPAs is in the agriculture and SME segment within priority sector and textiles, which account for almost 40% of total NPAs. Does this mean that we can expect the NPA ratios to increase substantially in the future?
RBI has been critical of the interconnectedness of banks and the fact that there is a systemic risk posed to other segments of the financial system. This is serious because, first, the asset liability mismatches caused with the assets being financed by borrowings, from others sectors such as insurance and mutual funds when coupled with the declining quality of assets poses a serious risk for the other segments too. It has pointed out that banks have relied excessively on short-term borrowings from mutual funds leading to potential liquidity and rollover effects. Here, clearly, there is need to have some set guidelines on how the banks should manage their balance sheets. Today, with the repo window becoming a permanent one, there is a tendency for such funding to be taken for granted, which sort of converts it to a major source of funding.
Second, any slippage in terms of quality of large banks can have a ratchet effect on others too. Their own analysis shows that a contagion can lead to a maximum loss of over 16% of capital with the largest ones being vulnerable to such risks.
But how is one to read the entire report? A financial stability report is to outline the risks involved in the system as well as economy, which it does adequately. But are we to be worried about it? Worried, probably no, but concerned, yes. This holds for the financial system because there are some very disturbing signs on the quality of assets as well as interconnectedness of banks. The ones pertaining to the economy are clearly well known and hence do not really come as a shock.
But RBI does not offer any solution for either the economy or the financial system. Therefore, the report tends to read like a note of caution on all aspects, highlighting the risks and the worst-case scenarios for various aspects. Therefore, it reads more like the ‘weaknesses’ and ‘threats’ part of the SWOT analysis, leaving out the strengths and opportunities.
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