Growth data of domestic economy show optimism which will provide strong impetus too
By Dr K Srinivasa Rao
Much of how the banks shape their growth strategies in 2023 will depend upon the evolving macroeconomic dynamics whose roots lie in 2022. Banks face domestic and external sector risks in an integrated world order. It can be recalled that when Covid was receding in early 2022, major central banks in the world were on a binge to normalise easy money policies that were aligned to fight the pandemic ills. But the invasion of Ukraine by Russia in February 2022 overturned the global economic landscape.
Sanctions against Russia, surge in energy and commodity prices, continued supply-side disruptions, aftermath of ‘Zero Covid policy’ in China and increasing polarisation of economies exacerbated geopolitical risks. Inflation made a galloping rise, interest rates soared and volatility became the watchword on markets ranging from stocks and bonds to cryptocurrencies and Chinese real estate. The appreciation of the US dollar against domestic currencies and the flight of overseas funds back to developed economies exacerbated exchange rate challenges.
While the fears of the resurgence of Covid19 in many parts of the world now cannot be ignored, India is said to be better placed with its strong immunisation campaign and wider exposure of society to the virus, forming hybrid immunity.
RBI Strategies
The Reserve Bank of India (RBI) joined the policy normalisation along with its global peers while customising it to domestic needs. It opted for a tectonic shift in monetary policy beginning in May 2022 steeply raising the repo rate by 225 basis points to fight inflation. It was coupled with absorbing excess liquidity using the variable rate reverse repo (VRRR) tool and retained low fixed rate reverse repo intact at 3.35%.
Banks quickly needed to fine-tune liquidity risk management as the cost of funds soared and resource inflows slowed. At the same time, the RBI continued its innovative strategies by introducing Standing Deposit Facility (SDF) on April 8 at an interest rate of 3.75%, which now stands at 6%, for absorbing excess liquidity.
As the impact of fiscal and monetary policy actions of 2022 and external sector dynamics work their way to shape the challenges and opportunities in the economy, the banking industry is set to enter another aggressive growth orbit in 2023. Banks will have to sync their functional barometer in line with the evolving macroeconomic ecosystem to make the most out of it.
Influenced by the demand for credit from reviving trade and industry, bank credit growth rose fast during 2022 to reach 17.5% while deposits were sluggish at 9.9% as on December 2, 2022. The incremental credit deposit (CD) ratio has been staying above 100% since August 2022. Even the flow of funds to the commercial sector has been expanding at a faster pace which should work to stimulate growth. Due to changed resources, banks plunged into stiff liquidity mismatches that needed heightened resource augmentation strategies.
While the cost of resources has gone up due to the rise in interest rates on deposits, loans had to wait to get repriced until their Marginal Cost of Funds Based Lending Rates (MCLR) were reset. The excess investment made in SLR (Statutory Liquidity Ratio) securities beyond the statutory limit of 18% during pandemic times when demand for credit nosedived also helped. Such excess liquidity could be now used to meet expanding credit.
But going forward, 2023 will definitely be the year of depositors who may enjoy positive real rates of interest with inflation plunging and deposit rates going up. The stiff competition for deposits will further heighten rates.
Stronger Headwinds
When the economy is strong, sectors grow well and banks can unleash their potential. It is noteworthy that the macroeconomic fundamentals are getting stronger against the backdrop of GDP in Q1 growing at 13.5% and in Q2 at 6.3%. The trend reflects a strong sequential momentum where private final consumption expenditure and gross fixed capital expenditure are looking up. The fiscal is expected to end GDP at 6.8% with Q3 and Q4 at 4.4% and 4.2%, respectively, providing strong impetus to banks. While the global GDP and cross-border trade are on descent, the growth data of the domestic economy resonates with optimism.
The external spillover risks to inflation continue to haunt and that could potentially add imported inflation to it. Tapering of crude oil prices, now close to $80 a barrel, is a significant positive development that could provide a speedy revival of the economy. Despite the innate resilience of the Indian economy, sensitivity towards emerging global risks in articulating a forward pathway of growth-inflation dynamics is the right way to be pragmatic.
Green Addition
In addition to diminishing inflation and stable growth headwinds, the findings from the RBI surveys of households, businesses and professional forecasters provide ample optimism for growth prospects. Banks while bracing to meet stiff challenges of liquidity risk management due to increased demand for credit will have to, in addition, work out strategies to finance green projects to reduce carbon footprints and achieve the UN Sustainable Development Goals. Financing such projects will need different wherewithal, including risk assessment and risk management systems.
National Bank for Financing Infrastructure and Development (NaBFID), now fully equipped, will be able to provide support to banks in infrastructure lending, including green projects. National Asset Reconstruction Company Ltd – Bad bank – should also ease the burden of toxic loans of banks to create space for fresh lending.
Banks have already set up 75 digital banking units adding new scope for financial inclusion that can be tapped for speedy resource augmentation and digital lending. The pilot rollout of central bank digital currency (CBDC) even for retail use should be able to add speed to digital penetration eventually reducing the circulation of physical currency. Considering the merits of next-gen opportunities in 2023, banks should explore technology-led innovations to set a new global benchmark.