Economic Highlights

New Delhi, 5 November 2012

High NPA, Inflation, Liquidity Crunch

LAST VISTAS OF ECONOMY COLLAPSING!

By Shivaji Sarkar

The Indian banking system is getting deep into a crises underscored by Reserve Bank of India’s (RBI) latest monetary policy. Wherein, the Crash Ration Reserve (CRR) cut exposes the grave liquidity situation.

Undeniably, the liquidity pressures pose risks to credit availability for productive purposes and could adversely affect overall investment. Excess liquidity, on the other hand, could increase money supply and aggravate inflation risks.

The war of words between the RBI and Government exposes this malaise. The Central Bank has alleged the Government’s failure in managing inflation as also growth and related issues. Whereby, the growth rate has been moderated from 6.5 per cent to 5.5 per cent. Notwithstanding, the ultimate might be much lower.

True, the Government might a have dislike for the RBI’s refusal to cut interest rates given that it is under pressure from corporate, which are sitting on their high reserves. But RBI knows for sure that the economy has little to cheer about. Indeed, it has taken a prudent step in not reducing the repo rate which leads to an interest rate cut. In a way, letting the banks decide on the issue as deposits are declining while losses are rising.

According to the RBI, banks are not managing their finances well highlighted by their monetary policy’s fine prints. Importantly, the issue is not cutting interest rates. The US, where interest rates on deposits are a mere one per cent since 2001 has done so by diverting funds from the banks. Perhaps, one of the reasons for the severe 2007-08 financial breakdown.

Notably, the RBI’s message is strong and succinct. It has called upon the banks to maintain high deposit rates so that there is no further liquidity crunch. Recall, deposits have increased but the Central Bank feels this is a temporary phase as banks are still considered safe parking option.

All the same, it wants lending rates to moderate wherein banks should work on low margins and high volume. They need to invite more deposits and create a conducive atmosphere for higher lending. Which could be achieved by banks reducing their costs and making banking affordable. This is what RBI Governor D Subba Rao told them the banks when he asked them to improve their services.

Significantly, the 25 points CRR cut points to the liquidity crisis the country is facing. By releasing Rs 17,500 crore into the banking system, it not only adds to liquidity but also exposes the banking system to a graver risk. While, the CRR cushions the banks from losing all their money in a volatile market where repayments are becoming scarce and non-performing assets (NPA) shooting up.

Besides, public sector banks’ gross bad debt (NPA) which was Rs 68,597.09 crore in December 2010 jumped over 51 per cent to a whopping Rs 1,03,891 crore in 2011 and continues to rise. Think. The NPAs and restructured loans stand at about nine per cent of advances and restructured advances amount to seven per cent.

The RBI estimates suggest about 20 per cent of the recast debt might turn into NPAs, too high by any standard. The aviation sector alone has an Rs 39,000 crore outstanding. Similarly, power companies have a total outstanding of Rs 1,21,000 crore.

Clearly, the slowing economic growth has adversely impinged on the repayment capacity of all categories of borrowers, especially small and medium enterprises. What RBI Governor Subba Rao told the Government when he said that 13 raises in interest rates could not moderate inflation. Instead, this had to be done by the Government on a priority basis to take the country on its growth trajectory.

The increase in wage cost, owing to high price levels, is yet another concern. The persistent increase in rural and urban wages, unaccompanied by commensurate productivity increase, has been and will continue to be a source of inflationary pressures, according to the RBI. As high wages also reduce generation of jobs.

Worse, the Government has not been able to contain supply side problems and boost production. Global commodity prices remain high. Asserted the Central Bank, “We will have to guard against their second-round effects on inflation”. It is apprehensive that food inflation would remain high.

Further, the large twin deficits --- fiscal and current account --- pose significant risks to both growth and macro-economic stability as high deficit and borrowings have a direct bearing on inflation. Wherein, if borrowings continue to rise it might constrict growth and make governance expensive.

As it stands, tax rates, direct, service, toll and user charges on energy, travel and other issues, are high which also adds to inflation. And the Government is in no mood to correct this. In reality, many steps that the Government has taken to “eliminate” the so called non-existent subsidies have only added to the cost push.

Undoubtedly, the RBI’s message is clear. It wants a new reforms process and has expressed its disapproval of the “structural reforms” that the Government has been harping on.

Remember, some time back Subba Rao had expressed concern over the virtual neglect of agriculture. His conclusion was based on the evidence pointing to diversion of Government-subsidised farm credit to other purposes which was not helping the farmers and instead was acting against the farm sector’s growth. Thereby, suggesting that the country could not grow if such practices which ignored the farm sector continued. As food inflation could be contained only if the farm sector fared better.

Significantly, the RBI has virtually said that there are limits to what the monetary policy could do to revive growth. The Government has to act firmly to reduce prices of all commodities and services. It cannot shed crocodile tears over inflation even as it goes on increasing taxes, charges and fees. The Central Bank seems to be advise that unless the Government acts, even the current low level of gross domestic product growth was not sustainable.

The third quarter monetary policy clearly spells out to the Government that the time for dithering is over.  It is worried that February 2013 onwards, the Government is likely to tow a policy of further populism to prepare for the 2014 Lok Sabha elections. This might further increase the fiscal deficit and consequently inflation.

In sum, the RBI has therefore given a stern warning. If this is not heeded and inflation remains above levels, growth might further slow down. This might lead to an overall crisis whereby, this time the financial and banking sector which has been sustaining the economy could break down. Time for the Government to heed the advice, else India could be in a worse situation than the US Lehman crisis. ----INFA

(Copyright, India News and  Feature Alliance)