A bumpy road ahead for RBI
The Reserve Bank of India (RBI) will have its hands full in 2018. It’s crunch time in many areas. The 40 big bad-loan accounts identified by the central bank for early resolution at the bankruptcy court will near their deadlines.
The central bank will have to ensure that banks are adequately prepared to absorb loan-losses. The details of the Rs2.11 trillion recapitalization plans for state-owned banks will be announced; the central bank will work with the government to identify the candidates for capital infusion.
Moreover, this is the year when the efficacy of RBI’s monetary policy will be tested severely. Globally, central banks are preparing to normalize their monetary policies by shrinking their bloated balance sheets. That will have implications on capital flows and there will be more bouts of uncertainty after a placid 2017 when asset price volatility hit record lows.
While retail inflation is expected to trend above 4% over the coming few months, conditions will get testier if the expected economic rebound does not take place. In this context, the markets will look upon the central bank for constant guidance on inflation, liquidity and growth. Thus, communications will become even more important.
That will be a change for the Urjit Patel-led RBI that has been a paragon of reticence. In the beginning of 2017, the Indian central bank faced a lot of flak from critics and politicians over its limited communication over the 8 November 2016 government decision to invalidate high-value banknotes.
The continued silence of Patel and frequent changes to rules on cash and banking transactions, which often seemed to be at the behest of the government, had former governors questioning whether the central bank’s independence was under threat.
In those days, RBI could seem to do nothing right. Even the monetary policy committee, which has three external members, came for criticism because it was seen to be voting as one bloc. It had also cut the policy rate by 25 basis points at its first meeting in October 2016, which was seen as bowing to government pressure. Subsequently, the central bank faced criticism for getting its inflation forecasts wrong; actual Consumer Price Index inflation tended to undershoot the forecasts. But by the end of the year, as retail inflation surged to a 15-month high of 4.88%, the central bank will feel vindicated.
Indeed, 2017 is also the year when RBI regained its reputation, for several reasons. One, the monetary policy committee has evolved to reflect a diversity of views. There has been at least one dissenting voice in the last four rate-setting meetings. It asserted its independence when external members refused to attend a meeting called by finance ministry officials to discuss interest rates ahead of a monetary policy review. Despite pressure from the finance ministry to cut interest rates to give a boost to the economy, the rate setting panel has stuck to its flexible inflation targeting mandate. It cut rates only once, in August.
Two, the governor has time and again strongly come out against farm loan waivers, which he said will impair credit discipline among borrowers. Patel has also repeatedly issued warnings about the inflationary impact of such loan waivers.
Three, the central bank has refused requests from the government to increase its dividend. In August, it paid Rs30,659 crore, about half of what it had transferred a year ago.
Four, the central bank has moved decisively towards resolving the bad loan mess. Although gross bad loans are scheduled to hit 11% of bank credit in 2018, RBI goading lenders to use the bankruptcy framework will offer much succour.
The 40 accounts it has identified make up nearly 40% of the system’s stressed assets of Rs10 trillion. The central bank has been inflexible, rightly so, in not acceding to lenders’s requests for more time to resolve these loans and stretch deadlines.
These 40 accounts are just one item in RBI’s to-do list to be ticked off in 2018. This year will see the endgame for these bad loan accounts. RBI will play an active role in seeing the resolution to the logical end and ensure that credit growth accelerates. Here, too, communication is necessary, with respect to the policies it lays down for banks.
The central bank will also have to clarify its position on bitcoin. While the government has issued a statement saying it considers cryptocurrencies to be no more than Ponzi schemes, there is a need to have a policy around it.
The central bank will also likely focus on ensuring better monetary policy transmission, one of its constant bugbears in the year gone past. A committee set up by the central bank has recommended linking bank lending rates to a market benchmark, but that remains a work in progress.
Lastly, the central bank’s communication about the direction and stance of monetary policy will become all the more important.
That’s especially because the fiscal deficit is showing signs of overshooting the budgeted target.
A combination of high inflation and low growth at a time when there will likely be government pressure to cut rates ahead of the 2019 general election will test RBI’s mettle.