The finance ministry on Tuesday said that downside risks to the official GDP growth forecast of 6.5% in 2023-24 dominate upside risks, given the hardening of oil prices, troubles in the global financial sector and subdued monsoon forecasts. It, however, reposed faith in the country’s strong banking system and said it is less prone to Silicon Valley Bank type failures, as Indian banks are well placed to handle any stress emanating from the current monetary tightening cycle.
“Opec’s surprise production cut has seen oil prices rise in April, off their lows of low-Seventies per barrel in March. Further troubles in the financial sector in advanced nations can increase risk aversion in financial markets and impede capital flows. Forecasts of El Nino, at the margin, have elevated the risks to Indian monsoon rains,” said the finance ministry’s Monthly Economic Review for March 2023.
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Interestingly, the ministry’s comments are somewhat at divergence with the State of the Economy report for April, written by top RBI staffers, where they suggested that there could be positive surprises to the IMF, which recently cut its India growth estimate for the current fiscal to 5.9% from 6.1%. Pinning hopes on the corporate capex revival in the year, the RBI officials noted many industries like cement, oil and gas, textiles and data centres were looking up. “Although too early to tell, most recent data arrivals suggest that multilateral institutions – the IMF, in particular – might encounter forecast errors, with actual outcomes surprising them positively,” the RBI report had said.
The Economic Survey 2022-23 has projected the country’s real GDP expansion for FY24 to be in the range of 6-6.8%, while the RBI in the latest monetary policy statement raised its forecast to 6.5% from 6.4% earlier.
While the economy is estimated to have grown by 7% in FY23 by the National Statistical Office, international agencies and private forecasters expect growth to slow down to less than 6% or remain just a tad above 6% in the current fiscal. The International Monetary Fund has lowered India’s GDP forecast to 5.9% in the current fiscal although the RBI has recently marginally raised its projection to 6.5% from the previous 6.4%.
“The collapse of a few regional banks in the United States and the takeover of the crisis-hit Credit Suisse by the Union Bank of Switzerland (UBS) have sent ripples across the global banking industry and posed fears of a contagion effect across economies,” said the latest finance ministry report, adding that it raised questions among policymakers on the vulnerability of their financial system to such a collapse, especially in Emerging Market Economies (EMEs) that may lack the fiscal space to calm financial markets with fiscal packages.
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“The multifaceted nature of RBI’s regulatory actions, the improved bank balance sheets and the attunement of the Indian banking system to frequent interest rate cycles augur well for India’s financial stability and significantly reduce the probability of an SVB-like event occurring in India,” the report said.
Various measures have been taken such as the creation of an investment fluctuation reserve (IFR) to create a buffer to shield banks from adverse yield movements, uniform application of capital and liquidity requirements to all banks as well as guidelines on governance in commercial banks to deal with any root cause of vulnerabilities, it noted, adding that the Reserve Bank of India undertakes meticulous bi-annual assessments of scheduled commercial banks, shadow lenders as well as cooperative banks that help identify weaknesses which may be impacted relatively more by monetary tightening and yield spikes.
Apart from regulatory requirements and actions, the ministry noted that certain characteristics of the banking system will also help reduce the probability of an SVB-like incident occurring in India. To this end, it highlighted that as of March 2022, 60.1% of India’s deposits are with public sector banks. Further, 63% of total deposits are owned by households considered sticky retail customers and therefore deposit withdrawals in this category will remain limited.
It also pointed out that Indian banks don’t hold a majority of their assets in the form of bonds. Instead, for the top 10 banks in terms of asset size, loans constitute more than 50% of their total assets, making banks more immune to the rising interest rate cycle. Asset-Liability Mismatch (ALM) is another threat that emerges as policy rates are hiked but it is not an onerous issue in the Indian banking system.
Interest rate cycles have also been quite prominent in India, and exposure and attunement to regular interest rate cycles have made Indian banks well equipped to handle the cycles, the ministry said. Further, the spread between deposit rates and the policy rate in India is much lower compared to that in the US, which makes “withdrawal of deposits en masse an improbable event”, it said.
According to the finance ministry, these factors will also help support the medium-term growth trajectory to remain on course. It, however, stressed that it is important to remain vigilant against potential risks such as El Nino conditions creating drought conditions and lowering agricultural output and elevating prices, geopolitical developments and global financial stability.
“All these three could affect the favourable combination of growth and inflation outcomes currently anticipated,” the report said.
The ministry, however, stressed that even as external stability strengthened, factors contributing to internal stability also improved.
While fiscal parameters for the Centre and the states in FY23 were robust, internal macroeconomic stability has further strengthened with easing inflationary pressures in March 2023, driven by the softening of food and core inflation.