RBI policy: How Urjit Patel and MPC are slowly working to restore credibility

The big takeaway from Reserve Bank of India (RBI)’s sixth bi-monthly policy review on Wednesday is that the apex bank doesn’t expect demonetisation to be a major spoiler in the economy, even differing from the CEA (chief economic advisor) estimates presented a day before the Union Budget.

Hence, the RBI has retained a growth forecast of 6.9 per cent for this fiscal, way above what the government’s chief economic advisor had predicted (6.5 per cent) and what the IMF predicted (6.6 per cent). The RBI also expects the growth to rebound sharply in the next fiscal to 7.4 percent on assumptions that discretionary spending by consumers held back by demonetisation will revive by next year, economic activity in cash-intensive sectors will be ‘rapidly’ restored, bank lending rate cuts will spur demand and expected increase in government spending will aid growth.

This stance of MPC/RBI also explains the status-quo in policy rates today. There is no pressing need to cut rates in an economy, where growth is expected to pick up sharply. This is sharply in contrast with the government’s chief economic advisor’s view on the economy that is more pessimistic.

If RBI’s predictions come true, this is good news for the economy. But, the risks to RBI's optimism lies in the continuing uncertainty following the demonetisation impact, and also the fact that three out of the four conditions listed out by the central bank for things to improve lies in ‘normalization’ economy from the self-inflicted demonetisation shock and no additional factors.

Urjit Patel, Governor, RBI. Reuters

Urjit Patel, Governor, RBI. Reuters

The fourth, increased government spending, is something one needs to wait and watch given the fiscal constraints on the government’s finance.

The worrying part is that even after three months, the MPC and the central bank still doesn’t seem to know how exactly the demonetisation impact will play out. “The committee decided to change the stance from accommodative to neutral while keeping the policy rate on hold to assess how the transitory effects of demonetisation on inflation and the output gap play out.”

In short, all the optimism on growth is based on certain expectations that, if holds true, augurs well for the economy, which is still struggling to wriggle out of the demonetisation impact. For the common man, the news of two-phased removal of cash curbs is a welcome one. Finally, the central bank has come out to give a guidance and roadmap on the cash situation that’ll help to arrest the cash hoarding tendency, but only if ATMs and bank branches have enough cash.

The second major takeaway from the policy and the presser followed is that the MPC and governor, Urjit Patel, are making certain attempts to regain their voice and warn the government on certain critical issues, mainly the issue of non-performing assets (NPAs) and issue of bank recapitalisation. Patel has clearly presented the issue of bad loans to government as a prerequisite for effective monetary transmission and future rate cuts.

“The Committee believes that the environment for timely transmission of policy rates to banks lending rates will be considerably improved if (i) the banking sector’s nonperforming assets (NPAs) are resolved more quickly and efficiently; (ii) recapitalization of the banking sector is hastened; and, (iii) the formula for adjustments in the interest rates on small savings schemes to changes in yields on government securities of corresponding maturity is fully implemented,” the policy says.

This is a clear and direct message to the government, which owns 70 percent of the banking sector, that it needs to act to sort out the problems in the banking sector, else need to pay a heavy price. As this writer has highlighted in the previous column, the Narendra Modi-government has so far miserably failed to adequately address the banking sector problems.

The Rs 10,000 crore set aside for state-run banks this year is far too inadequate to repair their cracked balance sheets, help them meet the mandatory minimum capital requirements under an advanced capital framework and equip them to finance the growth of an economy as and when demand recovery happens. Remember, a Rs 10,000 crore capital infusion is no additional fund, but only part of the ongoing plan under which government will infuse Rs 70,000 crore in state-run banks over a period of four years.

Considering the kind of stressed assets in the banking sector this is a pittance and the market was expecting much more. During his speech, Jaitley said the government will take care of the additional capital requirements of these banks, but past experience have shown such assurances have hardly materialised. It is even more critical now to address the capital woes of state-run banks since banking system is neck-deep in NPAs.

Going by what deputy governor, S S Mundra said in the RBI presser, at least 20 percent of the loans given by Indian banks are at risk (bad loan and restructured loans combined), majority of which lies with the state-run banks. As the majority shareholder and owner of these banks, the government cannot escape from the responsibility of the NPA problem and recapitalisation needs of state-run banks. This is something the MPC and Patel has highlighted in the policy document today.

The ball is now in government’s court to act on these fronts. By listing the conditions on NPA resolution, bank recapitalisation issue and reminding about the pressing need or higher public expenditure, both the MPC and Patel are slowly getting back in the game from being mere spectators.

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Updated Date: Feb 08, 2017 17:06:10 IST

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