The Reserve Bank of India today released the Financial Stability Report (FSR) for June 2015. It presents a more resilient picture of the economy, but warns about Indian banks' high levels of bad loans that have worsened their ability to repay debt.
BANK DEBT WARNING
Banks' leverage has increased, the report said, which will further strain a sector groaning under bad loans. High levels of corporate debt are hindering banks' ability to pass on lower interest rates and boost loans.
Monetary policy transmission has been a major headache for the RBI. India's banks have made only nominal cuts to base lending rates despite a 75 basis point reduction in the central bank's policy rate since the start of the year. Governor Raghuram Rajan has previously asked banks to respond with more agility to the three rate cuts by the central bank this year.
Infrastructure remains among the most stressed sectors, accounting for 15 percent of all advances but 29.8 percent of stressed loans, as of December 2014. Five sectors -- mining, iron and steel, textiles, infrastructure and aviation -- account for more than half of bad debts. "Besides its adverse impact on banks' balance sheets, high leverage of corporates may hinder the transmission of monetary policy impulses, as corporates may not be in a position to benefit from falling interest rates due to high levels of debt," the report said.
The report also said the banking sector would need to increase cash set aside for loan losses if the economy worsened. Stress tests carried out on Indian banks showed that gross non performing assets as a ratio to total loans could rise to 4.8 percent by September, from 4.6 percent in March.
Indian banks, especially state-run banks, have been hit hard by a surge in bad loans after the sharp slowdown in economic growth that followed the 2008 financial crisis. The report said banks should proactively manage their capital and not just adhere to the minimum regulatory requirements. It warned that in a stressed scenario, capital constraints and margin pressure would further impair banks' ability to pass on any monetary policy signal.
If macroeconomic conditions worsened, the RBI forecast the bad loan ratio could rise to around 5.9 percent and banks would have to "bolster" the provisioning to meet expected losses.
ECONOMY CAN WITHSTAND SHOCKS
Rajan said global financial markets might be more volatile, similar to the 'taper tantrum' in 2013 that sent the rupee falling.
“With the back-to-back quantitative easing stimulus programs by other major central banks, alongside possible tightening by Fed, what we have seen might be only one of a series of ‘tantrums’ that the global financial markets are likely to witness,” Rajan wrote in a forward to the report.
Rajan, a former International Monetary Fund chief economist, has been one of the most vocal critics of monetary stimulus policies deployed by developed economies. He has said they pose risks to global sustainable growth, particularly if such actions are not taken in coordination with developing nations.
But India is better prepared this time round. “A combination of global factors and concerted domestic policy decisions have helped, to a considerable extent, in improving the macroeconomic fundamentals of our economy as also in building additional buffers against future uncertainties,” he said in the report.
The report also said that a sub-normal monsoon and uncertainties about global crude oil prices remain remain significant risks to inflation in the short run.