The challenges of containing inflationary pressures limit what monetary policy can do: RBI governor-Raghuram Rajan

Reserve Bank of India (RBI) Governor Raghuram Rajan said the macro-economic adjustment is far from complete, with persistence of high inflation amidst growth slowdown. Moreover, fall in domestic savings and high fiscal deficit are other major concerns for India, commented the governor in the foreword of the central bank's financial stability report.

The outlook for the economy has improved, with export growth regaining momentum, but growth is still weak. The challenges of containing inflationary pressures limit what monetary policy can do. To maintain the momentum gained by the respite, it is imperative that long-delayed legislative reforms are pushed through, stalled infrastructure project clearances continue and fiscal consolidation remains on track.

This report came in one week after the mid quarter monetary policy review wherein the RBI unexpectedly kept the interest rates unchanged this month after raising them by a total of 50 basis points in September and in October.

However, the RBI said it will be vigilant. If the expected softening of food inflation does not materialise and translate into a significant reduction in headline inflation in the next round of data releases, or if inflation excluding food and fuel does not fall, the Reserve Bank will act, including on off-policy dates if warranted, so that inflation expectations stabilise and an environment conducive to sustainable growth takes hold. The Reserve Bank's policy action on those dates will be appropriately calibrated.

On the Current Account Deficit front, the report said, the delay in tapering allowed India to bring about adjustment in the current account deficit (CAD) and build buffers by replenishing its foreign exchange reserves. However, realignment of global growth as well as high inflation differential between advanced economies (AEs) and Emerging Markets and Developing Economies (EMDEs) is a potential source of exchange rate volatility and may result in volatile cross-border flows with every repricing of risk.

Meanwhile, corporate performance continues to be weighed down by boom period expansions and excess capacities, amid shifting asset composition towards financial investments. House prices and outstanding loans for housing by housing finance companies have grown relatively faster during the last few years. Also the risks to the banking sector have further increased since the publication of the previous FSR in June this year. All major risk dimensions captured in the Banking Stability Indicator show increase in vulnerabilities in the banking sector. Asset quality continues to be a major concern for Scheduled Commercial Banks (SCBs). The Gross Non-performing Assets ratio of SCBs as well as their restructured standard advances ratio has increased. Therefore, the total stressed advances ratio rose significantly to 10.2 per cent of total advances as at end September 2013 from 9.2 per cent of March 2013. Five sectors, namely, Infrastructure, Iron & Steel, Textiles, Aviation and Mining together contribute 24 percent of total advances of SCBs, and account for around 53 per cent of their total stressed advances.

Non Performing Assets (NPAs) of the banking sector need to be tackled on a priority basis to ensure that they do not grow to alarming proportions. The current level of NPAs do not pose a systemic concern as the CRAR of the banking system is above the prescribed levels and many projects are just delayed, not unviable. But we cannot be complacent, noted RBI governor in foreword.

Macro stress tests on credit risk suggest that if the adverse macroeconomic conditions persist, the credit quality of commercial banks could deteriorate further. However, under improved conditions, the present trend in credit quality may reverse during the second half of 2014-15, said the governor. Action to create central repositories for the banking sector, corporate bond market and insurance sector has been initiated. This move is expected to break the information asymmetry in those markets.

" With confidence in the financial system still fragile, six years into the crisis, policy certainty is something investors look for in the current environment," Rajan wrote in his foreword.

"A stable new government would be positive for the economy," he added.

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