Lokpal BillRBI?s fairly candid assessment of the economic outlook, for both the global and home markets, leaves one with the feeling that while all may not be well, there?s no reason to panic. Perhaps that?s the message the central bank?s trying to send through the Financial Stability Report IV: Don?t be alarmed but don?t also be complacent and what the central bank has done is to highlight the stress points, whether at a macro or micro level.
The good news is that there?s financial stability whether in the banking system or in the equity markets, although some risks may have emerged since June this year, when the central bank last took stock of the situation. Moreover, going by the tenor of the report, there?s very little chance of this stability coming undone. Going by the macro-environment globally right now when it looks like the US economy is going to have a good third quarter with a real GDP growth that?s better than the 1.3% reported for the second quarter, and China is likely to have a soft landing, the central bank?s reading of the situation seems to be spot on. Nevertheless, RBI has alerted us on the possible consequences, should things take a turn for the worse. The central bank cautions that the global recovery will take longer than earlier anticipated, highlighting that the recent European Union summit has failed to reverse the negative sentiment. The problems in the eurozone are clearly not going away soon and, as RBI mentions in the report, a series of sovereign rating downgrades among euro area countries is expected in the near future. That could mean a continuing reversal of capital flows?both debt and equity?from emerging markets.
In this context, the central bank doesn?t really dwell on the value of the rupee, the sharp depreciation of which has been the most disruptive of factors impacting the Indian economy since July this year. Pointing out that, after a long period of stability, the exchange rate has broken out of an established range to touch historic highs and that currencies of emerging markets that run current account deficits like India, Turkey or South Africa have yielded more ground than currencies of countries with a current account surplus, the central banks notes that the difference between the prices of onshore forward market and the NDF (non-deliverable forward) market for the rupee has been changing over time. By way of a guidance on where the Indian currency could head, the central bank says the extent and the direction of the movement will depend on a credible resolution to the external situation, particularly the sovereign debt problems in Europe. And it reiterates that the central bank?s role is to manage volatility in the exchange rate and to ensure that the volatility does not impair macroeconomic stability.
This is probably the RBI?s way of telling the corporate sector that it should be prepared for more depreciation in the currency and shouldn?t expect too much central bank intervention. In fact, RBI has expressed concern at the unhedged corporate positions and has suggested that banks set out a limit on such exposures. In the meantime, RBI is beefing up the reporting mechanism so that it has an idea of how much debt is unhedged. The central bank also hints at how much more difficult its job has become when it comes to managing external shocks; for instance, the reserve coverage ratios for both short-term debt as also volatile capital in June 2011 remain more or less where they were in September 2008.
Also, the country?s net external liabilities have risen: net claims of foreigners on India stood at $233.6bn in the quarter ended June 2011, an increase of $14.2bn over the quarter ended March 2011, mainly due to an increase in direct investments and ECBs. But life is clearly more difficult for companies sitting on ECB and FCCB exposures because FCCBs raised in pre-crisis years, at zero or very low coupons, will need to be refinanced through domestic sources at higher interest rates. Whether domestic banks want to fund this exposure, and even if they want to, whether they can, is another question altogether. That?s because they are more vulnerable today than they were in June with pressures on profitability due to higher funding costs and deteriorating asset quality in a slowing economy. If loan losses go up, it would mean setting aside more by way of provisions, which, in turn, mean lower profits. This, at a time when capital is hard to come by. RBI has said that exports could taper off and growth could fall below 7.6% this year (not in the report). For its part, it seems to be bracing for difficult times.
shobhana.subramanian@expressindia.com