Wednesday, March 21, 2018

Highlights of RBI’s Sixth Bi-monthly Monetary Policy Statement, 2017-18:

Policy Measures
  • The Monetary Policy Committee (MPC) decided to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.00%.
  • Consequently, the reverse repo rate under the LAF remains unchanged at 5.75%, and the marginal standing facility (MSF) rate and the Bank Rate are at 6.25%.
  • The decision of the MPC is consistent with a neutral stance of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4% within a band of +/- 2%, while supporting growth. 
Global economic activity has gained further pace with growth impulses becoming more synchronised across regions. Among AEs, the Euro area expanded at a robust pace, supported by consumption and investment. The US economy lost some momentum with growth slowing down in Q4 of 2017 even as manufacturing activity touched a multi-month high in December. The Japanese economy continued to grow as manufacturing activity gathered pace in January on strong external demand. Economic activity accelerated in EMEs) in the final quarter of 2017. The Chinese economy grew above the official target, driven by strong domestic consumption and robust exports. However, some downside risks to growth remain, especially from easing fixed asset investment and surging debt levels. In Russia, strong private consumption, rising oil prices and high exports are supporting economic activity, although weak investment and economic sanctions are weighing on its growth prospects. In Brazil, data on household spending and unemployment were positive in Q4. However, recovery remains vulnerable to political uncertainty, which has dampened consumer confidence. South Africa continues to face challenges on both domestic and external fronts, including high unemployment and declining factory activity.

Global trade continued to expand, underpinned by strong investment and robust manufacturing activity. Crude oil prices touched a three-year high as production cuts by the OPEC coupled with falling inventories weighed on the global demand-supply balance. Bullion prices touched a multi-month high on a weak US dollar. Inflation remained contained in most AEs and was divergent in key EMEs due to country-specific factors.

Global financial markets have become volatile in recent days due to uncertainty over the pace of normalisation of the US Fed monetary policy. The volatility index (VIX) has climbed to its highest level since Brexit. Equity markets have witnessed a sharp correction, both in AEs and EMEs. Bond yields in the US have hardened sharply, adding to the upward pressures seen during January, with concomitant rise in bond yields in other AEs and EMEs. Forex markets have become volatile as well. Until this episode of recent volatility, global financial markets were buoyed by investor appetite for risk, corporate tax cuts by the US, and stable economic conditions. Equity markets had gained significantly in January, driven by robust Chinese growth, uptick in commodity prices, and positive corporate sentiment in general. In currency markets, the US dollar had touched a multi-month low on February 1 on fiscal risks and improving growth prospects in other AEs.

In India as per the first advance estimates released by the CSO is estimated to decelerate to 6.1 per cent in 2017-18 from 7.1 per cent in 2016-17 due mainly to slowdown in agriculture and allied activities, mining and quarrying, manufacturing, and public administration and defence services. Manufacturing output boosted the growth of IIP in November. After a period of prolonged weakness, cement production registered robust growth in November-December, which along with continuing healthy growth in steel production led to acceleration of infrastructure goods production in November. The manufacturing purchasing managers’ index (PMI) expanded for the sixth consecutive month in January led by new orders. Assessment of overall business sentiment in the Indian manufacturing sector improved in Q3 as reflected in the Reserve Bank’s Industrial Outlook Survey (IOS). However, core sector growth decelerated in December due to contraction/deceleration in production of coal, crude oil, steel and electricity. Acreage in the case of wheat, oilseeds and coarse cereals was lower than last year and there was a higher shortfall in area sown for rabi crops as of end-January.

 Retail inflation, measured by year-on-year change in the CPI, increased for the sixth consecutive month in December on account of a strong unfavourable base effect. After rising abruptly in November, food prices reversed partly in December, reflecting mainly the seasonal moderation, albeitmuted, in prices of vegetables along with continuing decline in prices of pulses. Cereals inflation moderated with prices remaining steady in December. However, inflation in some components of food – eggs; meat and fish; oils and fats; and milk – increased. Fuel and light group inflation, which showed a sharp increase in November, softened somewhat in December, driven by moderation in electricity, LPG and kerosene inflation.
CPI inflation excluding food and fuel, increased further in November and December, largely on account of increase in housing inflation following the implementation of higher HRA for government employees under the 7th CPC award. Inflation also picked up in health and personal care and effects. Reflecting incomplete pass-through to domestic petroleum product prices, inflation in transport and communication remained muted in December. Inflation also slowed down in clothing and footwear, household goods and services, recreation, and education. Organised sector wage growth remained firm, while the rural wage growth decelerated.

The liquidity in the system continues to be in surplus mode, but it is moving steadily towards neutrality. The weighted average call rate (WACR) traded 12 bps below the repo rate during December-January as against 15 bps below the repo rate in November. On some days in December and January, the system turned into deficit due to slow down in government spending and large tax collections, which necessitated injection of liquidity by the Reserve Bank. For December as a whole, however, the Reserve Bank absorbed Rs. 316 billion (on a net daily average basis). For January, on the whole, the Reserve Bank absorbed Rs. 353 billion.

Merchandise exports bounced back in November and December. While petroleum products, engineering goods and chemicals accounted for three-fourths of this growth, exports of readymade garments contracted. During the same period, merchandise import growth accelerated sequentially with over one-third of the growth emanating from petroleum (crude and products) due largely to high international prices. Gold imports increased – both in value and volume terms – in December, after declining in the preceding three months. Pearls and precious stones, electronic goods and coal were major contributors to non-oil non-gold import growth. With import growth exceeding export growth, the trade deficit for December was US$ 14.9 billion. Even though the current account deficit narrowed sharply in Q2 of 2017-18 on a sequential basis, it was higher than its level a year ago, mainly due to widening of the trade deficit. While net FDI inflows moderated in April-October 2017 from their level a year ago, net FPI inflows were buoyant in 2017-18 (up to February 1). India’s foreign exchange reserves were at US$ 421.9 billion on February 2, 2018.
 GVA growth for 2017-18 is projected at 6.6 per cent. Beyond the current year, the growth outlook will be influenced by several factors. First, GST implementation is stabilising, which augurs well for economic activity. Second, there are early signs of revival in investment activity as reflected in improving credit offtake, large resource mobilisation from the primary capital market, and improving capital goods production and imports. Third, the process of recapitalisation of public sector banks has got underway. Large distressed borrowers are being referenced for resolution under the Insolvency and Bankruptcy Code (IBC). This should improve credit flows further and create demand for fresh investment. Fourth, although export growth is expected to improve further on account of improving global demand, elevated commodity prices, especially of oil, may act as a drag on aggregate demand. 

Headline inflation averaged 4.6 per cent in Q3, driven primarily by an unusual pick-up in food prices in November. Though prices eased in December, the winter seasonal food price moderation was less than usual. Domestic pump prices of petrol and diesel rose sharply in January, reflecting lagged pass-through of the past increases in international crude oil prices. Considering these factors, inflation is now estimated at 5.1 per cent in Q4, including the HRA impact.
Developmental and Regulatory Policies
  • Relief for MSME Borrowers: (for which the aggregate exposure of banks and NBFCs does not exceed ₹ 250 million as on January 31, 2018), MSMEs who have registered under GST, be allowed by banks and NBFCs to pay the amounts overdue as on September 1, 2017 and payments due between September 1, 2017 and January 31, 2018, within 180 days from their original due date, as a measure to support their transition to a formalised business environment.
  • Remove the currently applicable loan limits of Rs. 50 million and Rs. 100 million per borrower to Micro, Small and Medium Enterprises, (Services) respectively, for classification under priority sector.
  • It has been decided that the sub-target of 8 percent of Adjusted Net Bank Credit (ANBC) or Credit Equivalent Amount of Off-Balance Sheet Exposure (CEOBE), whichever is higher, will be made applicable for lending to the small and marginal farmers for foreign banks with 20 branches and above from FY 2018-19. Further, the sub-target for bank lending to the Micro Enterprises in the country of 7.50 percent of ANBC or CEOBE, whichever is higher, will also be made applicable for foreign banks with 20 branches and above from FY 2018-19.
  • It has been decided to harmonize the methodology of determining benchmark rates by linking the Base Rate to the MCLR with effect from April 1, 2018. 
  • With a view to harmonizing regulations across different types of collateral and also to encourage wider participation, especially for corporate debt repos, the repo directions are proposed to be streamlined and simplified. 
  • It is now proposed to allow non-residents hedging their INR currency risk arising out of their current and capital account transactions to dynamically hedge their currency and interest rate exposures onshore using any of the permitted instruments.
  • It is now proposed to merge position limits across all foreign currency-INR pairs and provide a single limit of USD 100 million per user (both resident and non-resident) across all exchange traded currency derivatives, in all exchanges combined. 
  • It is proposed that (i) FBIL would assume the responsibility for standardising the valuation of Government securities (issued by both the Centre and States) currently being done by FIMMDA; and, (ii) FBIL would also assume the responsibility for computation and dissemination of the daily “Reference Rate” for Spot USD/INR and other major currencies against the Rupee, which is currently being done by the Reserve Bank.
  • With a view to providing customers of NBFCs with a cost-free and expeditious grievance redress mechanism, it has been decided to introduce an Ombudsman Scheme for NBFCs. The scheme will cover all deposit taking NBFCs and those with customer interface having asset-size of Rupees One Billion and above. 
  • Standardize the note printing processes, procurement of raw materials, quality assurance processes, security, etc.
  • With a view to promote a less cash economy it has been decided to discontinue the incentives for installation of Cash Recycler Machines (CRMs) and Automated Teller Machines (ATMs).

Highlights of the Union Budget for 2018-19

Introductory Remarks
Budget 2018-19 reflects the Government’s firm commitment to substantially boost investment in Agriculture, Social Sector, Digital Payments, Infrastructure and Employment Generation on the one hand and simultaneously stick to the path of fiscal rectitude by aiming for a reduction of fiscal deficit by 0.2% of GDP over RE 2017-18.

Fiscal situation
  • Fiscal deficit target for 2018-19 at 3.3% of GDP to accommodate higher demand for expenditure against the earlier target of 3%. Revised deficit target for the year ending in March 2018 is 3.5% of GDP from the targeted 3.2%. Revenue deficit shot up to 2.6% of GDP in 2017-18 from the budget estimate of 1.9% of GDP (as receiving GST revenue for 11 months in 2017-18 led to a shortfall of Rs.50,000 crore).
  • Aims to reduce its debt-to-GDP ratio to 48.8% in 2018-19, 46.7% in 2019-20 and 44.6% in 2020-21. Nominal GDP for BE 2018-2019 has been projected at Rs. 18722302 crore assuming 11.5% growth over the estimated GDP of Rs. 16784679 crore for 2017-18 (RE).
  • Revenue receipts budgeted at Rs. 1725738 crores for 2018-19 against a BE of Rs. 1515771 and RE of Rs. 1505428 crore for 2017-18. Centre’s tax revenues at Rs. 1480649 crore in BE 2018-19 against a BE of Rs. 1227014 crore and RE of Rs.1269454 crore in 2017-18. Non- tax revenues at Rs. 245089 crore in BE 2018-19 against a BE of Rs. 288757 crore and RE of Rs. 235974 crore in 2017-18.
  • Total expenditure is budgeted at Rs. 2442213 crore for 2018-19 as against a BE of Rs. 2146735 crore and RE of Rs. 2217750 crore in 2017-18.
  • BE of Expenditure for 2018-19 show an increase of Rs. 2,24,463 crore over the RE 2017-18. Increases have occurred for higher —compensation to States and UTs for revenue loss on roll out of GST; payment of interest under Market loans; food subsidy under National Food Security Act; Defence, Civil and pensions payable to erstwhile employees of Department of Telecommunications, absorbed in Bharat Sanchar Nigam Limited; outlays provided for investment in Indian Railways, School Education and Literacy, Higher Education Financing Agency, Atomic Energy Industries and Construction of roads; capital expenditure of Defence Services; higher requirement by Central Armed Police Forces; provision made for Pradhan Mantri Swasthya Suraksha Yojana.
  • Borrowings and Other Liabilities estimated at Rs. 624276 crore in BE of 2018-19 as against a BE of Rs. 546531 crore and RE of Rs. 594849 crore in 2017-18.
  • Total resources going to States including the devolution of State’s share in taxes, Grants/Loans, and releases under Centrally Sponsored Schemes in BE (2018-19) is Rs.12,69,435 crore, with a jump of Rs. 1,53,558 crore over RE (2017-18) and Rs. 2,83,760 crore more than the Actuals (2016-17).
  • Disinvestment target for this year set at ₹80,000 crore.

Tax proposals

Personal income tax
  • No changes in personal income tax slabs.
  • Salaried tax-payers to get a standard deduction of Rs. 40,000 in lieu of transport allowance and "other medical expenses".
  • All senior citizens will now be able to claim benefit of a deduction of Rs. 50,000 for any medical insurance.
  • For critical illnesses, the deduction has been increased to Rs. 1,00,000.
  • Govt. will contribute 12% of the wages of new employees in EPF in all sectors for next 3 years. Women’s contribution to EPF reduced to 8% for first 3 years
  • 2,000-crore fund for development of agri markets.
  • Free power connections to 4 crore homes under Saubhagya Yojana. Rs. 16000 crore under this scheme
  • Eight crore free gas connections for poor women through Ujjwala Yojana.
  • Govt. to implement minimum support price for all crops; It is hiked to 1.5 times of production costs.
  • New flagship National Health Protection Scheme, providing a health insurance cover of ₹5 lakh per family per year announced.
  • Automatic revision of emoluments parliamentarians every five years, pegged to inflation.
  • develop and upgrade existing 22,000 rural haats into Gramin Agricultural Markets (GrAMs). In these GrAMs, physical infrastructure will be strengthened using MGNREGA and other Government Schemes. These GrAMs, electronically linked to e-NAM and exempted from regulations of APMCs, will provide farmers facility to make direct sale to consumers and bulk purchasers.
  • Organic farming in large clusters, preferably of 1000 hectares each, will be encouraged.
  • Allocation of Ministry of Food Processing is being doubled from `715 crore in RE 2017-18 to `1400 crore in BE 2018-19.
  • Rs. 500 crore ‘‘Operation Greens’’ to promote Farmer Producers Organizations (FPOs), agri-logistics, processing facilities and professional management.
  • Export of agricommodities to be liberalized. state-of-the-art testing facilities in 42 Mega Food Parks to be set up.
  • Volume of institutional credit for agriculture sector raised to Rs. 11 trillion for the year 2018-19 from Rs. 10 trllion in 2017-18.

Wednesday, November 29, 2017

Moody’s upgrades India’s sovereign bond rating after 14 years

the rationale
Moody's Investors Service has upgraded the Government of India's local and foreign currency issuer ratings to Baa2 from Baa3 and changed the outlook on the rating to stable from positive. Moody's has also raised India's long-term foreign-currency bond ceiling to Baa1 from Baa2, and the long-term foreign-currency bank deposit ceiling to Baa2 from Baa3. The short-term foreign-currency bond ceiling remains unchanged at P-2, and the short-term foreign-currency bank deposit ceiling has been raised to P-2 from P-3. The long-term local currency deposit and bond ceilings remain unchanged at A1. According to the Moody’s PR on 14 November 2017, a rating committee was called to discuss the rating of the India, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutional strength/ framework have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer's susceptibility to event risks has not materially changed.
The decision to upgrade the ratings is underpinned by the expectation that continued progress on economic and institutional reforms will, over time, enhance India's high growth potential and its large and stable financing base for government debt, and will likely contribute to a gradual decline in the general government debt burden over the medium term. In the meantime, while India's high debt burden remains a constraint on the country's credit profile, Moody's believes that the reforms put in place have reduced the risk of a sharp increase in debt, even in potential downside scenarios. While a number of important reforms remain at the design phase, Moody's believes that those implemented to date will advance the government's objective of improving the business climate, enhancing productivity, stimulating foreign and domestic investment, and ultimately fostering strong and sustainable growth. Measures include the Goods and Services Tax (GST) which among other things, is expected to promote productivity by removing barriers to interstate trade; improvements to the monetary policy framework; measures to address the overhang of non-performing loans (NPLs) in the banking system; and others which work towards fostering stronger institutions and a more formal economy.
Moody's expects real GDP growth to moderate to 6.7% in the fiscal year ending in March 2018 (FY2017-18). However, as disruption fades, assisted by recent government measures to support SMEs and exporters with GST compliance, real GDP growth is expected to rise to 7.5% in FY2018-19. Longer term, India's growth potential is significantly higher than most other Baa-rated sovereigns. While India's high debt burden remains a constraint on the country's credit profile, Moody's estimates that the reforms put in place have reduced the risk of a sharp increase in debt, even in potential downside scenarios.
The upgrade comes within five years of India being classified as one of the "fragile five" economies, struggling with high twin deficits in fiscal and current accounts. Since then a combination of policy decisions and external factors has worked in favour of an upgrade. The Finance Ministry has held on to the targets for fiscal deficit, while the current account has been bolstered by a period of low oil prices followed by a resurgence of global trade. India’s position in the World Bank’s Ease of Doing Business rankings jumped up by a record 30 notches to the 100th spot recently with relevant policy easing. The upgrade has been termed overdue by some as India was earlier in the same risk category as a number of economies with far worse macro-economic performance. Indeed a Bloomberg Economics model had predicted an upgrade based on the divergence between actual ratings and CDS implied credit ratings.
the benefits
The sovereign rating is an indicator of the government’s ability to meet its financial obligations. Sovereign credit ratings give investors insight into the level of risk associated with investing in a particular country and also include political risks. An upgrade thus lowers the cost of borrowing for the sovereign as it is associated with lower risk. In Moody’s rating, scale, bonds rated Baa3 and above are considered to be investment grade, meaning, these bonds are likely to meet the payment obligations better. India was at the lowest rung of the investment grade until it received this upgrade. The Indian government, it may be noted, does not fund its deficits via offshore commercial bond markets. External debt as a percentage of the Central Government’s total liabilities was at 6.2% in 2015-16. The entire public debt of India is funded via the domestic Rupee (INR) bond market. Foreign investor participation in the bond market, though increasing is very little, and tightly regulated through quotas. However, there are certain other benefits to be derived from a sovereign upgrade.
Sovereign ratings also act as the benchmark for other issuers of debt in the country. Effectively, sovereign upgrades or downgrades can affect borrowing costs for companies, individuals and any entity looking to raise money overseas. Moody’s upgraded some Indian corporate entities, mostly public sector companies along with the sovereign upgrade. This would result in reduction in cost of borrowing for Indian companies looking to raise financing from offshore bond markets. In fact, Reliance recorded the tightest ever spread for an Indian issue over US Treasuries in the offshore market soon after the upgrade.
The sovereign rating is an important indicator of the country’s financial and fiscal health. Foreign investors looking to commit money to direct investments, portfolio investments or local bond markets will all tend to look to the sovereign rating for a quick assessment of the country’s prospects. A ratings upgrade gives out a positive view on policy and builds incremental confidence in foreign investors. A higher rating can increase the range of investors, for example, drawing in global Pension and Life Insurance firms that have minimum ratings criteria for investing. Incrementally higher foreign flows tend to bid up INR too, making investments in a host of other Indian financial assets like equities and real estate more attractive to foreign investors.
and the caveats
Moody’s mentions that a material deterioration in fiscal metrics and the outlook for general government fiscal consolidation would put negative pressure on the rating. The rating could also face downward pressure if the health of the banking system deteriorated significantly or external vulnerability increased sharply. The upgrade has come in at a time when a gamut of short and long-term indicators has started to worsen. Given the emerging signs of quickening inflation and a widening current account and fiscal deficit a lot of policy balancing is in order.
S&P Global Ratings and Fitch Ratings, who now rate India a notch below Moody’s, hold the view that for an upgrade, India would have to address its weak fiscal balance sheet and weak fiscal performance. S&P Global Ratings, while acknowledging India’s stronger growth prospects and the country’s achievements on the reforms agenda, noted that its ratings were constrained by India’s low wealth levels, measured by GDP per capita. This and the income inequality hidden behind it, is indeed a macro-economic indicator which, on its own, needs far greater policy attention and careful planning than it has received so far.
Sources include:

Thursday, November 2, 2017

Government’s Rs. 2.11 trillion bank recapitalisation— Sufficient to cover stressed assets but no quick fix

The government, the largest shareholder will recapitalise the banks it owns by infusing an unprecedented amount of Rs. 2.11 trillion (US$32 billion), of which Rs. 1.35 trillion will be through recapitalisation bonds. Infusion of capital would help to fast-track the resolution of non-performing assets (NPAs) and take Indian PSBs closer to global capital adequacy norms. The move is expected help economic recovery with the revival of flow of credit to business and industry, and particularly foster medium and small industries growth and employment generation.
Public sector banks require capital mainly because of a sharp rise in NPAs in the last decade due to delays in repayments from sectors like power, steel and infrastructure. The gross NPA ratio reached 9.7 per cent in FY17, up from 7.8 per cent in FY16. Including loans that have been restructured the ratio of stressed loans rises to 12% of total banking sector loans. Weak credit discipline in banks, right from the appraisal to sanction stage, was recognised, by the RBI, as one of the main bank specific factors in the build-up of stressed assets. Swift, time-bound resolution or liquidation of stressed assets was recognised as critical for de-clogging bank balance sheets and for efficient reallocation of capital and a multi-pronged approach taken.  The Asset Quality Review (AQR) exercise undertaken in 2015-16 was a critical step in recognising the aggregate stock of NPAs across the banking system. Setting up of CRILC (Central Repository of Information on Large Credits) by the RBI in 2014, gave access to an aggregate view of borrower-wise and bank-wise exposures, to supervisors as well as lenders, to track the incipient stress in a particular account in a timely manner. The decision to do away with the regulatory forbearance regarding asset classification on restructuring of loans and advances effective April, 2015, was a significant step from the perspective of aligning the regulatory norms with international best practices. The system of ‘Prompt Corrective Action’ (PCA) ensures timely supervisory action in case banks breach certain risk-related trigger points. The enactment of the Insolvency and Bankruptcy Code, 2016 (IBC) puts a time limit of 180 days (extendable by a further 90 days) within which creditors have to agree to a resolution plan, failing which the adjudicating authority under the law will pass a liquidation order on the insolvent company (
The necessity for capital infusion had also been emphasised by various rating agencies such as Moody’s, CRISIL and Fitch, as well by RBI insiders. Moody’s estimated that the external capital requirements for the 11 rated PSBs, over the next two years would be around Rs. 700-950 billion, factoring in the two main drivers of their capital needs—the need to comply with Basel III requirements, and for conservative recognition and provisioning of their asset quality problems. Such an amount is much higher than the remaining Rs.200 billion previously budgeted by the government for capital infusion until March 2019. Under Basel III norms, being implemented in phases between April 2013 and March 2019, banks need to have a core capital ratio of 8% and a total capital adequacy ratio of 11.5% against 9% now. Capital adequacy is a measure of a bank’s financial strength expressed as a ratio of capital to risk-weighted assets (CRAR). A number of single factor sensitivity stress tests, based on March 2017 data were carried out, by the RBI, on SCBs to assess their vulnerabilities and resilience under various scenarios. SCBs’ resilience with respect to credit, interest rate, and liquidity risks as also due to drop in equity prices was studied. A severe credit shock is likely to impact capital adequacy and profitability of a significant number of banks. Under a severe shock of 3 standard deviations (that is, if the average GNPA ratio of 59 select SCBs moves up to 15.6 per cent from 9.6 per cent), the system level CRAR and Tier-1 CRAR will decline to 10.4 per cent and 7.9 per cent respectively. At the individual bank-level, the stress test results show that 25 banks having a share of 44.4 per cent of SCBs’ total assets might fail to maintain the required CRAR under the shock of a large 3 standard deviations increase in GNPAs. PSBs were found to be severely impacted with the CRAR of 22 PSBs likely to go down below 9 per cent.
The government is yet to disclose details on the structure and pricing of the Rs. 1.35 trillion recap bonds, as well as how it will raise the rest of the cash. It is expected that banks will subscribe to these bonds and hold it on their books as their investment. The funds which will go to the government will be reinvested as equity in the same banks. The programme is expected to have minor impact on its target to shrink the fiscal deficit to 3.2% of GDP in FY18, because the government will probably classify the bonds as off-balance sheet items as per permissible accounting norms. However, the government still has to bear the interest cost; to service the debt it will need to at least bear a cost of Rs. 80-90 billion, according to various unofficial estimates. Apart from the recap bonds, Rs. 0.18 trillion will come from the budget, in line with earlier provisioning under the Indradhanush scheme, leaving Rs. 0.58 trillion to be raised from the market. Front-loading of bonds is expected to increase the equity prices of PSBs. Rating agencies have called the government’s Rs. 2.11 trillion PSU bank recapitalisation plan significantly credit positive. Post the announcement, the 30-share BSE Sensex gained 387.96 points to open on 32,995.28 and the 50-share NSE Nifty gained 113.45 points to open on 10,321.15. Both the indices extended gains with Sensex breaching the 33,000-mark to touch the peak of 33,117.33 and Nifty scaling a fresh high of 10,340.55. PSU Banks were leading the rally in early trade with the Nifty PSU Bank sub-index jumping 22.76 per cent Most public sector banks’ shares have surged more than 20% since the announcement by the MoF.
However, apart from the modalities of the plan, questions that arise relate to its actual effect on the bond market, on governance issues of banks and its actual impact on the economy. The bond market faces a formidable supply load, even in the face of excess liquidity now being managed by RBI. Such large scale financing, though executed over two years and possibly held on books, could nevertheless, hamper the ability of the biggest subscribers, the PSBs, to invest in bonds and may push up yields eventually when liquidity dries up.  A series of banking reforms are to accompany the capital infusion, however, doubts definitely arise about moral hazards of such bail-outs as past experience of the 1990s has demonstrated that banks have not been able to shore up their lending practices so as to stem further build-up of toxic assets. Further, at this stage there are uncertainties about the appetite of borrowers with large overcapacities on GST implementation, and hence capital freed up for lending may not have immediate takers and not have much of the desired effect on economic revival. Again banks too may prioritize asset resolution and provisioning over expansion. Hence, the measure announced should not be seen as a one-shot solution to the banking sector’s and the economy’s current aliments, but rather as an important part of an integrated process, which still needs much careful planning and monitoring at each stage.

Friday, October 27, 2017

Highlights of RBI’s Fourth Bi-monthly Monetary Policy Statement, 2017-18:

Policy Measures
  • The Monetary Policy Committee (MPC) decided to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.00%.
  • Consequently, the reverse repo rate under the LAF remains unchanged at 5.75%, and the marginal standing facility (MSF) rate and the Bank Rate are at 6.25%.
  • The decision of the MPC is consistent with a neutral stance of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4% within a band of +/- 2%, while supporting growth. 
Global economic activity has strengthened further and become broad-based. Among advanced economies (AEs), the US has continued to expand with revised Q2 GDP growing at its strongest pace in more than two years, supported by robust consumer spending and business fixed investment. Euro area economic recovery gained further traction, underpinned by domestic demand. While private consumption benefited from employment gains, investment rose on the back of favourable financing conditions. The Japanese economy continued on a path of healthy expansion despite a downward revision in growth since March 2017 on weaker than expected capital expenditure. Strong growth in Q2 in China was powered by retail sales, and imports grew at a rapid pace, suggesting robust domestic demand. The Brazilian economy expanded for two consecutive quarters in Q2 on improving terms of trade, even as the impact of recession persists on the labour market. Economic activity in Russia recovered further, supported by strengthening global demand, firming up of oil prices and accommodative monetary policy. Although South Africa has emerged out of recession in Q2, the economy faces economic and political challenges.
The latest assessment by the WTO indicates a significant improvement in global trade in 2017, backed by a resurgence of Asian trade flows and rising imports by North America. Crude oil prices hit a two-year high in September on account of the combined effect of a pick-up in demand, tightening supplies due to production cuts by the OPEC and declining crude oil inventories in the US. Bullion prices touched a year’s high in early September on account of safe-haven demand due to geo-political tensions. Weak non-oil commodity prices and low wage growth kept inflation pressures low in most AEs and subdued in several EMEs, largely reflecting country-specific factors.

Global financial markets have been driven mainly by the changing course of monetary policy in AEs, generally improving economic prospects and oscillating geo-political factors. Equity markets in most AEs have continued to rise. In EMEs, equities generally gained on improved global risk appetite, supported by upbeat economic data and expectations of a slower pace of monetary tightening in major AEs. While bond yields in major AEs moved sideways, they showed wider variation in EMEs. The euro surged to a two and a half year high against the US dollar towards end-August on positive economic data. Most AE and EME currencies showed divergent movements.

In India GVA growth slowed significantly in Q1 of 2017-18, cushioned partly by the extensive front-loading of expenditure by the central government. GVA growth in agriculture and allied activities slackened in the usual first quarter moderation. Industrial sector GVA growth fell sequentially as well as on a y-o-y basis. The manufacturing sector – the dominant component of industrial GVA – grew by 1.2 per cent, the lowest in the last 20 quarters. The mining sector contracted, services sector performance, however, improved markedly, construction, as well as, financial, real estate & professional services,  picked up pace. Of the constituents of aggregate demand, growth in private consumption expenditure was at a six-quarter low in Q1 of 2017-18. Gross fixed capital formation exhibited a modest recovery in Q1 in contrast to a contraction in the preceding quarter.
The uneven spatial distribution of the monsoon was reflected in the first advance estimates of kharif production, which were below the level of the previous year.
IIP recovered marginally in July 2017 from the contraction in June on the back of a recovery in mining, quarrying and electricity generation. However, manufacturing remained weak. In terms of the use-based classification, contraction in capital goods, intermediate goods and consumer durables pulled down overall IIP growth. In August, however, the output of core industries posted robust growth on the back of an uptick in coal production and electricity generation. 
 Retail inflation, measured by year-on-year change in the CPI, edged up sequentially in July and August to reach a five month high. After a decline in prices in June, food inflation rebounded in the following two months, driven mainly by a sharp rise in vegetable prices. Cereals inflation remained benign, while deflation in pulses continued for the ninth successive month. Fuel group inflation remained broadly unchanged in August. Petroleum product prices tracked the hardening of international crude oil prices. CPI inflation excluding food and fuel also increased sharply in July and further in August, reversing from its trough in June.

A large liquidity overhang, fuelled mainly by the front-loading of government spend, which necessitated frequent recourse to ways and means advances and overdrafts over the greater part of this period, imparted a downside bias to overnight money market rates in H1 of 2017-18. Surplus liquidity in the system persisted through Q2 even as the build-up in government cash balances since mid-September 2017 due to advance tax outflows reduced the size of the surplus liquidity significantly in the second half of the month. Active liquidity operations narrowed the spread between the WACR and the policy rate from 31 bps in April to 13 bps in September. The RBI conducted OMO sales on six occasions during Q2 to absorb Rs. 600 billion of surplus liquidity on a durable basis. Net average absorption of liquidity under the LAF declined from Rs. 3 trillion in July to Rs. 1.6 trillion in the second half of September. The weighted average CMR, which on an average, traded below the repo rate by 18 bps during July, firmed up by 5 bps in September on account of higher demand for liquidity around mid-September in response to advance tax outflows.

Reflecting improving global demand, merchandise export growth picked up in August 2017 after decelerating in the preceding three months. Engineering goods, petroleum products and chemicals were the major contributors to export growth in August 2017; growth in exports of readymade garments and drugs & pharmaceuticals too returned to positive territory. Import growth remained in double-digits for the eighth successive month in August and was fairly broad-based. While the surge in imports of crude oil and coal largely reflected a rise in international prices, imports of machinery, machine tools, iron and steel also picked up. Gold import volume has declined sequentially since June. The sharper increase in imports relative to exports resulted in a widening of the CAD in Q1 of 2017-18, even as net services exports and remittances picked up. Net FDI at US$10.6 billion in April-July 2017 was 24% higher than during the same period of last year. While the debt segment of the domestic capital market attracted FPI of US$14.4 billion, there were significant outflows in the equity segment in August-September on account of geo-political uncertainties and expected normalisation of Fed asset purchases. India’s foreign exchange reserves were at US$399.7 billion on September 29, 2017.
 The projection of real GVA growth for 2017-18 has been revised down to 6.7 per cent from the August 2017 projection of 7.3 per cent, with risks evenly balanced. The loss of momentum in Q1 of 2017-18 and the first advance estimates of kharif foodgrains production are early setbacks that impart a downside to the outlook. The implementation of the GST so far also appears to have had an adverse impact, rendering prospects for the manufacturing sector uncertain in the short term. This may further delay the revival of investment activity, which is already hampered by stressed balance sheets of banks and corporates.

Headline inflation was projected at 3 per cent in Q2 and 4.0-4.5 per cent in the second half of 2017-18. Actual inflation outcomes so far have been broadly in line with projections, though the extent of the rise in inflation excluding food and fuel has been somewhat higher than expected. Taking into account domestic and international factors, including food prices, price revisions pending the GST, the house rent allowance by the Centre and international crude prices, inflation is expected to rise from its current level and range between 4.2-4.6 per cent in the second half of this year.

Developmental and Regulatory Policies
The RBI also set out various developmental and regulatory policy measures for further improving monetary transmission; strengthening banking regulation and supervision; broadening and deepening financial markets; and, extending the reach of financial services by enhancing the efficacy of the payment and settlement systems:

Measures to Improve Monetary Policy Transmission: Arbitrariness in calculating the base rate/MCLR and spreads charged over them has undermined the integrity of the interest rate setting process. The base rate/MCLR regime is also not in sync with global practices on pricing of bank loans. A Study Group has, therefore, recommended a switchover to an external benchmark in a time-bound manner.

Banking Regulation and Supervision: As a part of the transition to a LCR of 100% by January 1, 2019, the SLR will be reduced by 50 bps, from 20.0% to 19.50% of banks’ NDTL, from the fortnight commencing October 14, 2017. The ceiling on SLR securities under ‘Held to Maturity’ (HTM) will also be reduced from 20.25% to 19.50% of banks’ NDTL in a phased manner, i.e., 20.00% by December 31, 2017 and 19.50% by March 31, 2018.
High-level Task Force on Public Credit Registry (PCR) will propose a state-of-the-art information system, allowing for existing systems to be strengthened and integrated, and suggest a modular, prioritized roadmap for developing a transparent, comprehensive and near-real-time PCR for India. 
It has been decided to require banks to make it mandatory for corporate borrowers having aggregate fund-based and non-fund based exposure of Rs. 50 million and above from any bank to obtain Legal Entity Identifier (LEI) registration and capture the same in the Central Repository of Information on Large Credits (CRILC). This will facilitate assessment of aggregate borrowing by corporate groups, and monitoring of the financial profile of an entity/group.
The regulatory norms have been eased in order to enable all co-operative banks to open current accounts and maintain CRR with the Reserve Bank. All the regional offices of the Reserve Bank have been advised to issue no objection certificates for opening current accounts for all licensed co-operative banks other than those under all-inclusive directions.
The P2P platform has been notified as an NBFC under section 45I (f) (iii) of the Reserve Bank of India Act, 1934 as per the gazette notification published on September 18, 2017.
 Banks to put in place explicit mechanisms for meeting the needs of senior citizens and differently abled persons for availing banking facilities in branches.

Financial Markets:  The Reserve Bank shall put in place a framework for authorisation of electronic trading platforms (ETP) for financial market instruments regulated by the Reserve Bank. 
A Foreign Exchange Trading Platform is proposed for improving the pricing outcome for the “retail user” (to be defined in terms of transaction size) under which client pricing is directly determined in the market by providing customers with access to an inter-bank electronic trading platform where bid/offers from clients and Authorised Dealer banks can be matched anonymously and automatically.
Non-resident importers and exporters (NRIE) entering into rupee invoiced trade transactions with residents will be permitted to hedge their INR exposures through their centralised treasury/group entities. This is expected to facilitate internationalisation of the rupee by encouraging rupee invoicing of trade transactions while also encouraging non-residents to hedge INR risks onshore.
A detailed review of current regulations on FPI debt investment shall be undertaken to facilitate the process of investment and hedging by FPIs, keeping in mind macro-prudential considerations. Regulatory changes to be finalised in consultation with the Government of India and the SEBI will be effective from April 2018.
Smoother settlement of short sale transactions is necessary for orderly functioning of the market. Towards this end, it has been decided that (i) a short seller need not borrow securities for ‘notional short sales’, wherein it is required to borrow the security even when the security is held in the held-for-trading/available-for-sale/held-to-maturity portfolios of banks; and, (ii) OTC G-sec transactions by FPIs may be contracted for settlement on a T+1 or T+2 basis. 
 In order to further develop liquidity in the State Development Loan (SDL) market, spread the issuance of SDLs, move towards market-based pricing that is sensitive to individual state’s fiscal risk metrics, and reduce uncertainties in announcement of auction results, the following measures are being proposed:
  • Consolidation of state government debt will be undertaken to improve liquidity in SDLs through reissuances and buybacks, so as to even out redemption pressures and elongate residual maturity.
  • SDL auctions will be conducted on a weekly basis and the auction results will be announced latest by 3.00 PM on the same day.
  • High frequency data relating to finances of state governments available with the Reserve Bank will be disclosed on its website.
The Union Budget 2016-17 announced that the Reserve Bank will facilitate retail participation in the primary and secondary markets through stock exchanges. Accordingly, after consultation with the SEBI, it is proposed that:
  • specified stock exchanges, in addition to scheduled banks and primary dealers, will be permitted to act as aggregators/facilitators for retail investor bids in the non-competitive segment for the auction of dated securities and treasury bills of the Government of India.

Payment and Settlement:  In line with the Vision for Payment and Settlement Systems in the country, a revised framework will pave the way for bringing inter-operability into usage of PPIs.