Govt’s plan to recapitalize state-run banks is timely: Radhika Rao of DBS Bank
India’s Rs2.11 trillion recapitalization plan for state-owned banks is timely as it comes close to a likely increase in stressed advances—particularly consortium loans—after the Reserve Bank of India (RBI) completes its ongoing annual risk-based supervision, Radhika Rao, India economist at DBS Bank Ltd, said in an interview. The markets have given a thumbs-up to the recapitalization measure, and rating agencies also lauded the move, which prima facie removes one of the key supply-side hurdles for credit growth, she added. Edited excerpts:
Big picture, your take on the Indian government’s bank recapitalization plans.
Plans for record capital infusion into public sector banks is a welcome step and should boost confidence in the domestic banking system. This will also be timely as it comes close to a likely increase in stressed advances—particularly consortium loans—after the Reserve Bank of India (RBI) completes its ongoing annual risk-based supervision.
The key positive here is the sizeable quantum of support and an indication that help will be front-loaded to this year. A number of finer details on the recapitalization bonds including size, duration, issuance details and interest rates are awaited. Bank reforms have also been promised, but the exact contours are still to be announced. It also remains to be seen if the capital infusion is incentive/ performance-driven or applicable to all institutions. For now, odds of consolidation and M&As (mergers and acquisitions) in the banking sector appear low.
There is bound to be some impact on the centre’s finances as interest costs are reflected in the books, along with an increase in aggregate debt levels. On the technical end, the question on whether these recap bonds will be eligible to be considered as part of SLR (statutory liquidity ratio, or portion of deposits banks have to invest in government securities) calculation, will also have an implication on sentiment in debt markets, and yields by extension.
Going by the reaction in the banks’ stocks and equity indices, markets have given a thumbs-up to the recapitalization measure. Bond markets were, however, a lot more subdued, given the uncertainty over fiscal implications. Supportive comments from RBI governor that the measure will be liquidity-neutral and that the fiscal implications might be staggered over a period of time, should provide some relief. Rating agencies also lauded the move, which prima facie removes one of the key supply-side hurdles for credit growth.
How do you view India’s economic slowdown: Is it dire, or just a disruption?
Undeniably, the move to scrap a majority of currency in circulation in November and the rollout of a wide-ranging tax reform like GST (goods and services tax) in July, has disrupted the growth momentum.
But to pin the blame entirely on these factors is erroneous. These policy decisions only magnified the underlying softness in the growth momentum. Other factors are also responsible for this slowdown.
Investment spending has been on the slide for over 3-4 years, with its share as a percentage of GDP (gross doemstic product) falling by 3.6% of GDP from 1QFY16 to 1QFY18 on a four-quarter moving average basis. Private and government consumption has improved in the same period, but have proved insufficient to pick the slack entirely. Net exports have been a consistent drag on growth and has only added to overall growth in the most recent quarter.
Alongside, favourable tailwinds, particularly oil prices, have also reversed. Using net exports as a proxy, the windfall from low oil prices bumped up growth by circa 200 bps (basis points) between 2014 and 2016. With global oil prices now gradually getting off its back, the windfall is unwinding, slowing growth by roughly the same extent.
Into the second half of FY18, growth is expected to recover from the June quarter slump as one-off dampening factors fade and inventory is rebuilt after the pre-GST drawdown. But full-year growth is nonetheless still going to be below 7% on both real GDP and GVA (gross value added) basis, at a three-year low.
If we look at August data and what we have from September, are we seeing the first major signs of a turnaround for the industrial cycle? Overall, has the economic slowdown that began in 2013-14 finally bottomed out?
August data and early September numbers are encouraging, signalling a pick up from the slump in June-July. Both CPI (Consumer Price Index) and WPI (Wholesale Price Index) inflation for September undershot expectations as food costs corrected sharply. In the meantime, August industrial production jumped 4.3% y-o-y (year-on-year) from a revised 0.9% in July. The pick-up was broad-based... On demand-end, the pick-up was notable in primary and consumer goods segments, likely reflecting a gradual return in discretionary spending trends as GST-led uncertainty stabilizes. Capital goods segment also rose marginally, after a run of weak readings. While it is premature to assume that this marks a turnaround for the industrial cycle, sequential trends are likely to improve in the months ahead, even if not to the extent of August’s outcome. Festive demand and better consumption on higher allowances will also be of help.
Trade numbers have also improved. The trade deficit narrowed to $9 billion in September versus average $13 billion in April-August as exports rose by the fastest pace, outpacing imports. Trends suggested the GST-driven slowdown in the previous two months is beginning to wear off, along with a moderation in real rupee gains. The government’s recent efforts to expedite GST input credits to exporters and other supportive measures will also help India’s exports participate in the regional trade upcycle. Concurrently, auto sales, PMI (purchasing managers’ index) and high-frequency demand indicators have been supportive, but rural demand might slow on an uneven south-west monsoon and moderating incomes on weak prices.
You had recently made a case that foreign reserves accumulation is likely to moderate. Why is that? The high forex reserves are making up for the absence of any established sovereign wealth fund. Does it make sense for India to have a sovereign wealth fund like major economies?
India’s total foreign reserves touched a record high of over $400 billion in September. Adjusted for FX forwards, reserves are now even higher at $430 billion. This is a long way since reserves bottomed out at $275 billion at the worst point of the Fed taper tantrum. In fact, compared with peers in Asia ex-Japan, India’s foreign reserves have risen by the most since the 2013 taper tantrum. The stock has increased on back of strong foreign portfolio inflows, net investment flows and a narrower current account deficit.
Beyond the strong year-to-date jump, we expect the pace of reserves accumulation to moderate due to slower incremental portfolio flows and wider current account deficit. Any deterioration in global risk appetite will also require authorities to dip into reserves to defend against market volatility.
That said, the existing stock is high enough to cushion against an increase in external vulnerabilities. The import cover—on total reserves minus gold—is comfortable at 10-11x, better than the 7-8x seen during the 2013 taper tantrum. Total external debt eased to 1.2x of reserves from 1.3x last year. More importantly, short-term debt accounted for only 0.2x of reserves. The net international investment position (NIIP) deficit continued to widen in nominal terms. However, as a percentage of GDP, the ratio eased to -16.8% in FY17 from -18.3% in FY15.
With regards to your question on sovereign wealth fund (SWF), this debate has been ongoing for a few years now. Benefits of running a SWF are aplenty, including meeting strategic objectives, exploring overseas investment opportunities especially in resource industries, raising investment-led revenues, which in turn would add to the reserves stock, among others. But it is equally important to have sufficient financial resources to build and maintain such a fund over a long period of time. These will require a good budgetary cushion, along with strong reserves built ideally out of surpluses—in our case, much of this is on account of FDI (foreign direct investment), portfolio inflows, non-resident deposits, etc., Hence, while the creating SWF might be a good decision, the timing is not right at this juncture.
So far, India has refrained from more fiscal stimulus, and resorted to alternative measures to support growth. Do you see the Modi-led government sticking to this policy going forward, too?
The late-September sell-off in the markets reflected the multiple challenges faced by the government. Markets have since calmed down after the government refrained from adding more fiscal stimulus in favour of exploring alternative solutions that does not jeopardize macroeconomic stability.
There were also two reasons behind the hesitation to increase spending at this juncture. First, there is a need to strike a balance between growth and fiscal discipline. Second, more time is needed to assess downside risks to growth and revenue collections. Hence, we still see risks of a modest miss in the FY18 fiscal deficit targets from a revenue shortfall. A less rigid deficit target will also reduce the extent to which spending needs to be compressed in 2H FY18. Any final decision on the fiscal front is likely to be taken in November/December, closer to the last parliamentary session and ahead of the FY19 budget to be tabled in February 2018.
What is your outlook on interest rates in India?
As far as policy rates are concerned, the cycle has likely bottomed out and is likely to enter a pause mode for the rest of the year. Two aspects are of interest here. Firstly, there is a clear swing among members (of the monetary policy panel) towards a neutral than a dovish stance. Even if the revised inflation forecasts of 4.2-4.6% for the March quarter are undershot—likely a lower 3.8-4.2%—the trajectory is still close to the 4% target and, thereby, unlikely to prompt the central bank to reconsider rate cuts. Core inflation, meanwhile, remains elevated at above 4%.
Secondly, RBI likely views the ongoing slowdown as more cyclical than structural. We draw parallels with December 2016, when for example, after demonetisation, RBI defied rate-cut expectations and held rates. They argued the negative impact on growth from demonetisation would be transitory. Returning to the present, there was also a sense among panel members that structural reforms and resolution of the twin balance sheet stress—corporates and banks—was a more durable solution to lift growth, rather than monetary policy.
The debate over the optimal extent of real rates continues, with doves pointing to the present 300-400 bps cushion to lower rates. Their counterparts—we belong to this camp—point to a likelihood that inflation will settle around 4% in the next few quarters, is likely to see the band narrow to 150-200 bps levels considered optimal by the central bank.
Policy transmission, meanwhile, is likely to slow as well. To recall, the sharp fall in bond yields and bunched up rate cuts by domestic banks in the past year was due to favourable liquidity conditions, magnified by demonetisation. With surplus liquidity now narrowing to Rs1 trillion from Rs3-4 trillion in the earlier part of the year, it will be a challenge for banks to pass on lower rates, thereby impeding the transmission process. Hence, lending rates are likely to turn sticky on the downside this year.