The RBI’s Monetary Policy Committee has raised the repo rate by 25 basis points (bps) for the second time in a row with a 5:1 decision and positioned itself as an inflation warrior by sticking to the path of maintaining the 4 per cent inflation target.

The RBI revised its 2H FY19 forecast upwards by 10 bps to 4.8 per cent. It had revised upwards its inflation projection for the second half of the current financial year in its June review as well.

Clearly, it is watchful of inflationary pressures and cited risks such as firming household expectations, monsoon spread, impact of MSP (minimum support price) implementation and fiscal risks.

The RBI was sanguine about the growth prospects, citing improved foreign direct investment, broad-based pick-up in services growth and robust capacity utilisation in manufacturing.

Importantly, it pegged Q1 FY20 GDP estimate to firm up to 7.5 per cent. The RBI maintained its earlier estimate for GDP growth at 7.4 per cent in FY19 (up from 6.6 per cent in 2017-18), which it said was likely going to be driven by a revival of investment on the demand side and manufacturing on the supply side.

Capacity utilisation

The RBI’s business expectations index (BEI) for Q1:2018-19 remained optimistic notwithstanding some softening in production, order books and exports. The July manufacturing PMI too remained in expansion zone, although it eased from its level a month ago.

Capacity utilisation levels have been moving up in sync with the growth numbers. The RBI’s latest OBICUS survey has pointed out that capacity utilisation stood at 74.1 per cent in Q3:2017 and the seasonally adjusted CU also increased for the first time in FY18 to reach 74.3 per cent in Q3 .

While this is the aggregate snapshot which comes at a lag, what is required is to look at the sectoral picture more carefully at this stage where capacity utilisation levels are much higher.

In fact, the latest FICCI survey shows that capacity utilisation levels are in the 75-80 per cent range for sectors such as auto, chemicals, electronics, leather and footwear, machine tools, metals, paper products and textiles.

This leads us to the other important factor which is that the type of fund requirements in this phase of growth is quite different. The requirements will veer away from working capital loans.

Thus, while the headline debate in the near term will continue to focus on the “cost of funds” — that is, will the RBI raise by 25 or 50 bps, etc — the real issue will be to focus on “availability of funds” and ensuring it for the sectors that are beginning to feel the capacity pinch and may want to invest in enhancing capacities for the future.

Balance sheet shrinkage

More importantly, back home, there is something equally unprecedented taking place in the banking sector. Tectonic shifts are altering the pattern of credit intermediation.

Just a few banks — a clutch of private banks along with a handful of public sector banks — are driving India’s broken credit cycle recovery.



Public sector banks (PSBs) that comprise 70 per cent of the total banking system, hamstrung by poor balance-sheets, are yielding space to private players. Part of this is by design and partly accidental. Note, the government and the RBI have leaned heavily in favour of the bankruptcy code framework. Additionally, the RBI has put 11 PSBs in the prompt corrective action (PCA) framework list and reportedly six more are likely to be added to this list.

However, the fact that private banks will have to do the heavy lifting in meeting the credit needs of an economy which is beginning to recover from a series of policy interventions hereon is quite unprecedented, especially with an under-developed bond market backdrop.

The RBI has just sounded an even more sober assessment of PSBs. In its latest Financial Stability Report (FSR), the RBI estimates the gross non-performing assets (NPA) ratio — bad loans as a percentage of total loans — of the Indian banking system to reach 12.2 per cent by March 2019. This would be the highest since 2000.

RBI cautions

The FSR warned that if the macroeconomic conditions deteriorated, the gross NPA ratio could worsen to 13.3 per cent in March 2019. Among the bank groups, the gross NPA ratio for PSBs may increase from 15.6 per cent in March 2018 to 17.3 per cent by March 2019 in a scenario where the stress is severe.



Thus, with India’s investment cycle poised for a cyclical upswing from FY19, after years of sub-par performance, it is important that efforts are geared towards incentivising and nurturing sectors in need of funds before the cost of funds begin to bite. This is important given the global headwinds.

Global growth has become uneven and risks to the outlook have increased with rising trade tensions, currency war and contagion risks.

Economic activity in major emerging market economies (EMEs) has slowed somewhat and global trade has lost some traction due to intensification of trade wars and uncertainty stemming from Brexit negotiations.

The writer is Chief Economist, M&M. The views are personal.