The Reserve Bank of India (RBI) has an incredible job of choosing whether to fight inflation or boost economic growth. In the era of multi-objective, multi-instrumental monetary policy making, there was an inbuilt trade-off in objectives. The trade-off may not have been completely transparent, but overall, there was room for substantial manoeuvre. Since 2016, we have had the Monetary Policy Committee (MPC) regime, with a single mandate targeting inflation to be between 2% and 6%. This is in accordance with a contract between the central bank and the government. Failure to meet this flexible target for three consecutive quarters requires the offending party (ie, the MPC or the RBI itself) to explain the failure. The MPC has been hyper-adjustable for almost four years, long before the start of the pandemic. During the worst of the pandemic, monetary policy was used to its fullest. The Prime Minister’s Atmanirbhar Bharat Abhiyan relief package, placed at 10% of India’s GDP, was in the context of almost all liquidity injections or loan guarantees, or some debt restructuring. Fiscal restraint on performance then did not prevent the fiscal deficit from reaching 9.5% of GDP during FY 2020-21. With the loss of income and livelihoods, it was no surprise that initially the demand for state-guaranteed loans was low for small entrepreneurs. It took some time to cross the credit offtake under the Emergency Credit Line Guarantee Scheme (ECLGS) 2 trillion. In the end, this is not surprising. When business stops, a new loan, even if partially guaranteed by the government, is hardly a top priority.
The RBI additionally put a moratorium on loan repayments, providing additional relief through regulatory moratoriums. Major debt restructuring was offered through the Kamath committee, especially for the sectors worst hit by the pandemic. The moratorium had an adverse impact on the perceived extent of bad loans, or the ratio of non-performing assets (NPAs). The gross NPA ratio of the banking sector declined from 7.3% in March to 6.9% in September 2021. It was not only because of better recovery. This was partly the effect of relaxed regulatory norms that allowed loans not to be classified as NPAs. We must remember that in December 2020, RBI’s Financial Stability Report (FSR) had projected a scenario of 13.5% as Gross NPAs by September of the following year, even under severe stress conditions. increased to 14.8%. Naturally, there was much concern about asset quality, debt recovery prospects, survival of businesses badly hit by the pandemic and labor market prospects. By July 2021, the revised forecast as per FSR was more optimistic than before, but still the NPA ratio increased from 7.5% to 10% by March 2022 and 11.2% in severe stress. So, the FSR was a prudence keeper cautioning us about the real health of corporates, small businesses and retail buyers, while others were predicting a V-shaped recovery.
Not surprisingly, the MPC kept its monetary stance moderate throughout. Concerns about a weak recovery were seen to be overshadowed by worrying signs on the inflation front. Oh, don’t forget that the MPC exceeded its inflation target for most of the 12 months prior to April 2021, for which it was not met as stipulated in the targeting regime. In fact, there was even a RBI research report which recommended that the MPC “failure” rule be extended to four consecutive quarters of misses instead of three. The MPC’s lower-rate stance was happily cheered by the stock and bond markets. , and RBI’s statement about doing “whatever is required” for liquidity support was music to their ears.
For quite some time, our Wholesale Price Index (WPI) based inflation has been much higher than Consumer Price Index (CPI) inflation, the latter being the target mandate of the MPC. Surely, the 14% plus inflation rate of commodities captured by the WPI will eventually slip into retail prices, right?
And finally, amid the war in Ukraine, supply chain disruptions (partly due to lockdowns in major Chinese cities) and a global oil price that threatens to stay in the triple digits, the MPC has abruptly reduced rates and cash reserve ratios. has removed approximately 12% of the market’s liquidity.
The action comes hours before the US Federal Reserve hiked rates by 50 basis points. Much has been written about the shadow of recession in the Western world and despair over the endless war in Europe. Countries like Sri Lanka and Ghana are on the verge of default and bankruptcy, the world is also grappling with rising sovereign debt. Since 2008, we’ve seen massive wealth expansion and a growing mountain of debt, and it’s unclear how all of this will be pacified, even by utter defaults and rejections by sovereigns. low.
What needs immediate attention in the Indian context is the creation of NPAs. Huge write-offs, healthy tax collections and stupendous corporate profits of the last quarter should not leave us satisfied with hidden and rising NPAs.
The time for regulatory tolerance is over and the lessons from the fall of ILFS should not be forgotten. The actions of the MPC will certainly increase the interest burden and increase the pressure on loan repayments. That is why it is imperative that we do an immediate and fair examination of the books of the banks so that we can spot the rot before any further crisis escalates.
Ajit Ranade is a Pune-based economist