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Saturday, September 19, 2020

ExplainSpeaking – Economy: Why everyone expects NPAs to rise in India

Explaining what to expect next week, every Sunday morning: Not a single respondent in RBI latest systemic risk survey expected a V-shaped economic recovery

Written by Udit Misra , Edited by Explained Desk | New Delhi | Updated: July 27, 2020 4:40:20 pm
The RBI comes out with the FSR twice each year — once in June or July and the next time in December. The FSR provides one of the most authoritative accounts of the state of India’s financial stability.

Dear Readers,

This was a week dominated by the Reserve Bank of India and its Governors. In particular, we heard a lot about the growing threat of Non-Performing Assets (NPAs) in the Indian economy.

First came the comment from Raghuram Rajan, former RBI Governor, highlighting the limits of the RBI monetising government debt. In other words, the RBI cannot be expected to directly or indirectly fund government borrowings without risking a sharp spike in inflation.

Rajan also said that once economies like India open up fully, a lot of damage wrecked on the corporate sector by the lockdowns will be uncovered. In other words, Rajan suspects many firms may default on paying back their loans.

Then came the news of Rajan’s successor at RBI, Urjit Patel, launching his book, titled “Overdraft”. Here, too, the issue of defaults dominated.

According to Patel, the Insolvency and Bankruptcy Code (IBC), which was supposed to speed up and simplify the resolution of defaulting firms, created a rift between the RBI and the central government, as the latter sought to dilute the IBC.

In Patel’s view, resolution of firms failing to pay back their dues will be adversely affected. “Since the time-bound threat of insolvency application is not credible anymore, it is unclear what threat points will compel resolution in 180 days (or, for that matter, even 365 days),” Patel has written in his book.

Alongside came the news a new book by Viral Acharya, former deputy Governor of RBI. “Attempts to alter the governance structure of the RBI to institutionalise such outcomes in future would have meant crossing the Rubicon and had to be foiled. As a result, the RBI lost its governor (Patel) on the altar of financial stability,” stated Acharya.

Then came the release of the Financial Stability Report by the RBI.

The RBI comes out with the FSR twice each year — once in June or July and the next time in December. The FSR provides one of the most authoritative accounts of the state of India’s financial stability.

In the latest FSR, Patel’s successor and current RBI Governor, Shaktikanta Das, stated that Gross NPAs could rise from 8.5% (of gross loans and advances) at the end of March 2020 to as much 14.7% by March 2021 — a two-decade high.

The FSR is a veritable goldmine of information across various sectors. Each FSR also carries with it the results of a Systemic Risk Survey (SRS). This SRS — this one is the 18th in the series — was conducted during April-May 2020 to capture the perceptions of experts, including market participants, on the major risks faced by the financial system.

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56% of the respondents opined that the prospects of Indian banking sector are going to deteriorate in next one year

According to the survey results, all major risk groups viz., global risks, risk perception on macroeconomic conditions, financial market risks and institutional positions were perceived as ‘high’ risks affecting the financial system.

A detailed rendering of the SRS explains why all the RBI Governors — past and present — have cautioned about a rise in NPAs in the economy.

For instance, as Chart 1 shows, 56% of the respondents opined that the prospects of Indian banking sector are going to deteriorate considerably in the next one year.

Absolutely no one expects a “V-shaped” economic recovery

A central reason for this is that absolutely no one expects a “V-shaped” economic recovery

Lastly, Table 1 alongside points to those sectors of the economy that are likely to be the worst affected by this downturn.

Where does all this leave the RBI?

Sectors of the economy that are likely to be the worst affected by this downturn

India’s central bank has much on its plate. Many have argued that the RBI’s autonomy and independence have been undermined in the past few years. Others question the wisdom in the RBI solely targeting retail inflation level. Shouldn’t the RBI be targeting growth or unemployment levels instead, they ask. Then, of course, there is the challenge of NPAs that simply refuses to go.

Between August 2 to 4, the RBI’s Monetary Policy Committee will come together to answer some of these questions, albeit in their own way.

Till then, stay safe.

Udit

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