Though the RBI has been mopping up liquidity, it reversed its strategy to pump liquidity into the system through overnight variable repo auctions.
By Dr K Srinivasa Rao
A steeper rate hike by 50 basis points taking the repo rate to 5.9% much beyond the pre-pandemic levels was warranted due to the evolving global macroeconomic headwinds. It will logically hike deposit and lending rates but a timely flow of credit is more important than the cost of credit to keep the growth momentum going. It is necessary to go into the crux of challenges to revamp internal capabilities.
Just when the global economy was bracing to emerge out of the pandemic, central banks encountered yet another set of risks when Russia invaded Ukraine in February. Following sanctions against Russia, the zero-Covid policy of China, supply side disruptions and protracted war combined into a whirlwind of vociferous geopolitical storm calling for accelerated rate hikes and absorption of excess liquidity even if it meant sacrificing a few notches of growth in the near term. Driven by domestic economic considerations, the central banks in advanced economies (AEs) had to opt for a more aggressive policy action sharing a prolonged hawkish tone to fight the twin storms.
But the antidote of AEs to fight these two storms turned into yet another ‘third storm’ for emerging economies (EMs). Galloping interest rates, spurt in bond yields, strengthening of the dollar to a two-decade high by 14.5% (up to September) against a basket of major currencies piled up into another storm. It caused turmoil in currency markets globally depreciating even Euro and British Pound to historic lows against the US dollar while mauling many currencies in EMs due to the flight of foreign portfolio investments to AEs and heightening import bills.
Domestic Economy
Despite unprecedented uncertainty, the Indian economy continued to remain resilient. But in an interconnected world, it is difficult to remain unscathed from the geopolitical storms that transcend every sector of the economy. The domestic economy fared relatively well with 13.5% GDP growth recorded in Q1 of FY23 surpassing the pre-pandemic level by 3.8%. However, there are signs of downside external sector risks that outweigh the domestic growth indicators.
The eight infrastructure industries that comprise the core sector grew at the slowest pace in nine months at 3.3% in August owing to a higher base and deceleration in output growth. At the same time, other high-frequency indicators in Q2 reflect renewed confidence. Revival in urban demand could get a leg up during the festive season and rural demand too is gaining momentum. Investment demand is picking up opening up the employment sector.
In addition to the farm sector buoyancy, manufacturing purchasing managers index (PMI) expanded to 56.2 in August. The service sector PMI too bounced back – 57.2 in August from 55.5 in July – infusing confidence in markets. Though the domestic economy is building up further resilience, a realistic review of the growth trajectory is essential. Taking these varying factors in view, the RBI revised its GDP outlook down to 7% for FY23 from 7.2%.
However, the RBI retained its inflation projection intact at 6.7% for FY23 assuming that the crude prices will hover around $100 per barrel during H2 of FY23 instead of $104 in H1. The upside risks due to imported inflation may persist. Against the backdrop of the supportive central bank, active institutional involvement of financial intermediaries – more importantly, banks, will be necessary.
Bank Credit
Rightly so, there has been a considerable uptick in bank credit growth to 16.2% on an annualised basis (as on September 9) as against 6.7% in the previous year, signifying potential buoyancy. Banks have also shifted their focus back to the corporate sector that increased credit outgo. It is also noteworthy that the total flow of funds to the commercial sector has gone up to Rs 9.3 lakh crore from Rs 1.7 lakh crore in the previous year that could possibly be ploughed back to accelerate the revival of the economy. However, the subdued bank deposit growth at 9.5% could exacerbate the liquidity risks and banks need to be aggressive in augmenting deposit growth with compatible business strategies and differentiated product offerings.
With the National Bank for Financing Infrastructure and Development (NaBFID) becoming functional and the capex of the government flowing into infrastructure, term lending will get a boost, aiding growth. At the same time, National Asset Reconstruction Company Ltd – the bad bank, taking over some of the toxic assets can increase the capital adequacy ratio of banks to create added space for fresh lending.
High inflation needs calibrated withdrawal of monetary accommodation to restrain the broadening of price pressures, but the RBI continues to be proactive to keep the monetary and liquidity conditions accommodative while focusing on the gradual withdrawal of accommodation so as not to disrupt the liquidity ecosystem.
Though the RBI has been mopping up liquidity through its variable rate reverse repo auctions, it reversed its strategy to pump liquidity into the system through overnight variable repo auctions. With such liquidity adjustment facility (LAF) available in times of need, banks should be able to accelerate lending even if it takes time to mobilise deposit resources.
Scope of Lending
To boost credit growth, banks have to remain active in lending to multiple sectors with multipronged support coming from the RBI and other institutions designed for the purpose. Despite a rise in credit in recent times, the credit to deposit (CD) ratio of banks works out to 73.5 as on September 9.
According to TheGlobalEconomy.com ranking of countries measured in terms of CD ratio, India was ranked 77th globally in 2020. Around 27 countries in this ranking exhibit a CD ratio beyond 100. Therefore, there is considerable scope for credit expansion in India even with the existing pool of deposits by better managing liquidity risks. Banks may have to rejig features of deposit products to improve the structural maturity of assets and liabilities. They can use the excess of credit deposit ratio and statutory liquidity ratios, if any, to shore up lendable resources.
The present monetary policy while going beyond normalisation leaves enough space for banks to fund the potential growth of the economy to stay ahead as the fastest growing economy in Asia.