macroeconomics problem in india

8/13/2019 Macroeconomics problem in India

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Renu KohliTokyo, May 21st, 2012

The views expressed in this presentation are the views of the author and do not necessarily reflect the views or policies of the Asian

Development Bank Institute (ADBI), the Asian Development Bank (ADB), its Board of Directors, or the governments they represent.

ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of theiruse. Terminology used may not necessarily be consistent with ADB official terms.


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Outline

Current Macroeconomic Issues and Policies

How does the current slowdown impact the banking

Does all this change the long-term structural growth

story

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Economic performance: Brief profile

GDP growth averages 8.3% since 2003-04, from 6% in nineties

Well-diversified, evenly balanced, solid moorings: Investment shares rose from24% to 39% in 6-7 years; Savings jumped from 23.7% to 37%.

CAD between 1-2.5% of GDP for most part: Export growth >20% in the five

years to 2008; Import growth rapid, averaging 30% during 2003-2008; Oilmpor s a ou e s pace.

Weathered the crisis well as result: Ample policy space allowed appropriate policy

.

But the recovery has not sustained

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Growth has been slowing in 2011-12

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Weak investment driving current slowdown

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Inflation reigns high; recent slowing only from base effects

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Structural basis to inflation; temporary supply shocks

-capita income between 2004-05 and 2009-10

Consumption shift towards higher intake of proteins

Terms of trade shift towards agriculture

sca ax ty

Subsidy and welfare-schemes induced boost to consumption and ruralincomes

Global price increases in oil, commodities and food

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Supply-side response?

Long term decline in yields, stagnant productivity

consumption: pulses, edible oils, etc.

Heavy rain dependence, small holdings

Lack of public investment: weak rural infrastructure

ar et mper ect ons, ne c ent supp y c a n

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Large fiscal deficits, slow pace of consolidation

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Subsidies dominate spending; low public capex

2012/5/29 10Source: IMF Staff Report, 2012


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Revenues growth-dependent; borrowings rising

2012/5/29 11Source: IMF Staff Report, 2012


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Monetary responses to check inflation

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Monetary policy framework

Liquidity adjustment facility (LAF) key element in the operating framework ofmonetar olic

Single policy rate - Repo - signals stance; operates within corridor set by Bankrate and reverse repo rate (1%)

Objectives: Growth with price stability.

Operating targets: overnight call money rate (weighted average);

Operating objective: contain this rate around the repo rate within the corridor.

Other instruments to mana e ersistent li uidit : outri ht o en market

operations (OMO), cash reserve ratio (CRR) and market stabilisation scheme(MSS)

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How does it work in practice?

Monetary transmission substantially more effective in a deficit rather thana surplus liquidity situation; Most effective at the short-end of the yield

curve

Magnitude of liquidity ideal for effective monetary transmission [+ - 1%of net demand and time liabilities (NDTL) of banks] varies.

any s or ons mpe e sync ron za on

Rate controls on small savings deposits,

Statutory appropriation of bank reserves

Level of lender com etition

Asset-liability mismatches at banks

Recent deregulation of savings bank deposit rate

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Monetary policy transmission

Factors affectingliquidity: Government borrowings; intervention; low depositrowth

India: Yield curve (in percent)

10

Mar

2012Nov 20119

10

Apr

2012

Jan

2012

8

8

7

ON 3M 1Y 5Y 10Y

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Exchange rate policy: growing flexibility

Intermediate regime: does nottar et an articular REER level

Incorporated reserveaccumulation-cum-intervention

-inflows/outflows and avoidexcessive appreciation

Period of hands-off since 2009:no intervention or reserveaccumulation in this period

Current intervention to manageoutflow and currency pressures

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Wide, unsustainable external deficit

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Poor quality of financing

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controls


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Capital Controls: Current state of liberalization

Capital account still partially liberalized: Post crisis shift on use of capital

Equity: Unrestricted but 2 exceptions Restricted to approved FIIs. FIIs can only take equity participation up to 24% of firms capital, but can

FDI encourage; some sectors barred

Debt flows restricted:

FIIs participation in government & corporate bond market is capped., ,

beyond this, it is contingent on specific RBI approval. End-use restrictions apply. Banks/non-bank FIs - upto 50% of Tier I capital or US$10 million; short-term

portion of funds capped at 20% of unimpaired Tier I capital. GAAP limits apply.Likewise pattern for non-banks financial institutions.

Price/quantities varied to manage surges and ebb of short-term capital Interest rate wedge prevents arbitrage despite some porosity Reasonable success in navigating the trilemma

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Policy framework on capital flows

Explicitly stated capital account management framework

mp e po cy space or mu p e ns rumen s, .e. quan a ve m s, pr cebased as well as administrative measures

Short term debt: quantitative restrictions; only for trade transactions

Original sin, viz. excessive foreign currency borrowings by domesticentities, particularly the sovereign, avoided

Prudential regulations to prevent excessive dollarization of balance sheetsof financial sector intermediaries, especially banks

Cautious a roach to liabilit dollarisation b residents

Significant liberalization of permissible avenues for outward investmentsfor domestic entities.

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Macroprudential tools extensively used in India

These have been reasonably effective in preventing buildup ofimbalances, e.g. asset price bubbles

Key tools: risk weights; provisioning requirements; sectorexposure limits; LTV ratios, margin requirements and the buildup of foreign currency liabilities

ere espec a y use a ea o t e to restra n vers on ocapital inflows into asset price and credit boom

external sector policies and managing the capital account

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To contain asset price inflation: Stock prices

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Illustration: Recent policy responses to capital outflows

Since Sept. 2011: Intervention in forex marketto stabilize and manage expectations

.sovereign and corporate bonds ($5bn to $15

bn; $5 bn to $20 bn respectively)

Dec 2011: Prohibiting exporters fromcancellation and rebookin of forwardcontracts to check speculation (still remains inplace)

May 2012: Exporters were asked to liquidatehalf of their dollar holdings within a fortnight

May 2012: Intra-day trading limits for banksfixed at five times the limits on net overnightopen positions of banks (to check volatility)

Nov 11 & Apr 12: Interest rates on rupee andforeign currency deposits of NRIs

Apr 2012: Deregulation interest rate caps onforeign currency export credit raised abroad by

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Indian banks


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Future direction of capital account liberalization:

ey ssues an oa a ea

CA architecture corresponding to real economy; financial stability

Macroeconomic framework FDI flows:

Polic liberal barrin some sectors

Structural factors need to be addressed

Political convergence in some spheres

Portfolio flows QFIs: Implications; recent developments

Investments in debt Risks

Short-term vs long-term flows

Outflows

Access to financial markets NDF

Rupee for trade invoicing

CDS

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Banks impacted by the slowing growth

Global crisis shock

Weak economic recovery inadvanced economies

Pre-crisis credit boomaggressive lending by banks

Inflation; Monetaryti htenin

Current growth slowdown

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Trend in Growth Rate of Slippages and Gross NPAs

v s- -v s ross oans vances

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NPAs: Sector shares and growth rates, Sept 2011

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Impact: Profitability has fallen; capital dented

Change in CRAR and Net NPA

(End-Dec. 2011 over End-March 2011)

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Credit overhang: NPLs and restructured loans

2012/5/29 32Source: UBS Research


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Risks for banks ahead

Rising NPAs have been a big concern in 2011-12 turning public sectorbanks focus upon recovery

But a slowing economy is rapidly increasing the incidence of bad loans.

Material risks will arise in FY13 according to most analysts: NPAs likely tomigrate to lower categories (e.g. D2/D3/loss assets); higher incrementalprovisioning (25-75 bps)

Public sector banks, e.g. Union Bank, IOB, SBI, PNB and BoI have added

0.8-1.1% of advances into sub-standard and D1 categories over FY09-11. rms un er stress, ow pro a ty o mater a re uct on n nterest rates

imply a 20% jump in NPAs in FY13 while credit growth is expected averagejust 16-17%.

-

FY13: while interest rates have fallen after 50 bps monetary easing in April,deposit rates still high. Deposit growth


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Corporate deleveraging still incomplete

2012/5/29 34Source: UBS Research


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What is the potential for long-term growth?

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Fundamental, structural drivers of growth

Attractive demographics: Falling dependency ratios, rising labor force

High savings rate: Around 35% of GDP, India is now well above the emerging

similar dynamics to those that launched East Asias growth in the 1960s and

1970s. Higher infrastructure investment: Significant need for investments in

infrastructure like air orts, orts, roads, ower, and railwa s is likel to rovideinvestment opportunities. Planned - $1 trilion over 2012-17; some analystsestimate infrastructure investment of US$2.5trn in the next 15 years.Productivity improvements through small policy changes at existing technology can

deliver GDP growth of 8-9% pa for the next 10-20 years ,finance, are relatively low;, implying room for high-growth investment ideas

Global drivers expanding tradable sector Vibrant private entrepreneurship

The rural segment: Convergence

Diffusion and dispersion: top to bottom; centre to periphery

Inclusive growth dynamics boost and positive spillovers

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Potential spoilers and risks

Political shortcomings: bureaucratic restrictions and regulation

Poor state of infrastructure

Education, skills and literacy gaps

But often, such constraints can serve as sources of future growth as bottlenecksare gradually removed, e.g. China in the 1980s.

Potential areas of macroeconomic concern: State of national sheet: Fiscal deficits persistent and structural; current account deficit

stands out for its vulnerability to short-term, volatile financing. Inflation

Reversing the weakening savings-investment rates

Rising energy dependency

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macroeconomics problem in india

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