The resignation of the Reserve Bank of India Governor Urjit Patel on December 10, following a period of government pressure on the central bank to spur economic growth, highlights risks to the RBI's policy priorities, according to Fitch Ratings.

It warned that a roll-back of measures that address longstanding bad loan problems and restrict the growth of weakly capitalised banks could have a negative impact on the credit profiles of affected banks and increase risks in the financial system.

The global rating agency, in a note, observed that general elections due by May 2019 would give the government the political incentive to push for more supportive RBI policies.

“The RBI's efforts to address bad loan problems have the potential to improve banking sector health over the long term and its commitment to inflation targeting has supported a more stable macroeconomic environment in recent years. Increased government influence on the central bank could undermine this progress,” Fitch said in a note.

The agency felt that the full implications of Urjit Patel's resignation will only become clearer once there is some indication of the RBI's policy approach under his replacement, Shaktikanta Das, an experienced government bureaucrat. The central bank's stance may still remain unchanged, it added.

“Patel cited personal reasons for leaving the RBI, rather than government interference (for his resignation). Moreover, there was no obvious break in policy continuity after the last governor, Raghuram Rajan, decided not to seek a second term in 2016, which also sparked market concerns,” said the agency.

Nevertheless, Fitch observed that Patel's decision comes after months of escalating government pressure on the RBI to ease some of the strains created by its clean-up of the banking sector.

Increased bad loan recognition has led to large credit costs - particularly for state banks - and weaker capitalisation in recent years. Capital constraints had, in turn, held back lending, while 11 state banks had fallen under the RBI's "prompt corrective action" (PCA) framework, which allows the central bank to directly restrict their lending.

Problems in the non-bank financial sector following the recent default of Infrastructure Leasing & Financial Services (IL&FS) have further reduced credit availability.  ”The government has unsuccessfully pushed the RBI to relax the PCA thresholds to allow some troubled banks to step up lending. Calls to dilute provisions in a new regulatory NPL (non-performing loans) framework that has accelerated bad loan recognition this year and to provide emergency liquidity to non-bank financial institutions (NBFIs) have also been dismissed.

“The introduction of a 0.625% counter-cyclical buffer (CCB) that was set to kick in from April 2019 has been delayed, but the RBI has so far resisted pressure to push back the implementation of other Basel III minimum capital requirements,” elaborated the agency.

As per Fitch’s assessment, most state banks are in a poor position to ramp up lending, with their common equity Tier 1 ratios well below the 7.375 per cent that will apply from April 2019 under Basel III implementation. Some banks are also likely to continue reporting losses, further adding to capitalisation challenges, it added.

”In terms of monetary policy, the establishment of a Monetary Policy Committee (MPC) in October 2016 and recent introduction of inflation targeting has underpinned our view that the RBI's macroeconomic policy framework is credible and effective.

“However, that assessment could change if government influence pushes the RBI away from its mandate. We affirmed India's 'BBB-' sovereign rating with a Stable Outlook in November. India's economy remains one the fastest-growing in the world, but GDP growth slowed to 7.1 per cent year-on-year in 3Q18 (calendar year), from 8.2 per cent in the previous quarter. Fitch recently lowered its growth forecast for the fiscal year ending March 2019 to 7.2 per cent from 7.8 per cent, due to the weak data, higher financing cost and reduced credit availability.

 

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