1. The Reserve Bank’s Annual Report informs
the public both on the past year – our narrative of
economic events as well as what we intended to
accomplish during the past year – as well as what
we propose to do in the coming year.
Challenges in the Current Macroeconomic
Environment
2. Both the Government and RBI have been
engaged in the last few years in restoring
macroeconomic stability to the economy. While
the policy actions have had positive effects, there
are a number of areas which should be considered
“work in progress”. From RBI’s perspective, three
such areas continue to be of importance. First,
economic growth, while showing signs of picking
up, is still below levels that the country is capable
of. The key weakness is in investment, with private
corporate investment subdued because of low
capacity utilisation, and public investment slow
in rolling out in some sectors. Second, inflation
projections are still at the upper limits of RBI’s
inflation objective. With the Reserve Bank needing
to balance savers’ desire for positive real interest
rates with corporate investors’ and retail borrowers’
need for low nominal borrowing rates, the room
to cut policy rates can emerge only if inflation is
projected to fall further. Third, the willingness of
banks to cut lending rates is muted; not only does
weak corporate investment reduce the volume of
new profitable loans, their stressed assets have
tightened capital positions, which may prevent
them from lending freely. Certainly, the reluctance
to lend to industry and small businesses is more
visible among the more stressed public sector
banks compared to the private sector banks.
3. While these areas of concern have not
changed significantly over the year, there have been
some developments that bode well. Expectations
of a good monsoon (corroborated thus far) coupled
with more money in the hands of government
servants (as a result of the implementation of the
7th Pay Commission recommendations) should
boost consumer demand. With final demand picking
up, capacity utilisation is likely to increase, and so
will investment. A virtuous cycle of growth is
possible, reinforced by anticipation of the coming
benefits from reforms like the recently passed
Goods and Services Tax legislation in Parliament.
4. The short term macroeconomic priorities
of the Reserve Bank continue to be to focus on
bringing down inflation towards the government-set
target of 4 per cent – thus far the RBI has
followed a gentle glide path, aiming at 5 per cent
by March 2017 after having coming below 6 per
cent in January 2016; work with the Government
and banks on speeding up the resolution of
distressed projects and completing the clean-up
of bank balance sheets; ensure banks have the
capital to make provisions, support new lending,
and thus pass on future possible rate cuts. I
elaborate briefly on these priorities.
Inflation Target and MPC
5. The Government has notified the inflation
target for the RBI, and has outlined the structure
and functions of a Monetary Policy Committee.
Once the MPC is constituted, it will be entrusted
with making future policy decisions. This will be
a welcome step forward in strengthening the
transparency, continuity, and independence of
monetary policy.
Liquidity Framework
6. An important aspect of the new monetary
framework is liquidity management. RBI has
moved to a new liquidity framework in April 2016,
after a detailed review. There is now a clearer
differentiation between the durable liquidity
needs of the system and its short term liquidity
needs, with the RBI intending to move closer to
neutrality over the medium term on supplying
overall durable liquidity needs. When the RBI
gets to neutrality, periods of temporary liquidity
surplus should be broadly equalled by periods of
temporary liquidity deficit over the course of the
year. While net permanent liquidity needs will be
addressed through open market operations in
government bonds, taking into account any net
foreign exchange purchases, temporary liquidity
needs will be addressed through liquidity windows
and overnight/term repos/reverse repos.
Stressed Assets and Speedy Resolution
7. A third area of short term focus with
macroeconomic relevance is stressed asset
resolution. The Asset Quality Review initiated in
early 2015-16 has improved recognition of NPAs
and provisioning in banks enormously. Some
banks have taken significant steps in recognising
incipient stress early.
8. Now more focus should move to improving
the operational efficiency of stressed assets,
and creating the right capital structure so
that all stakeholders can benefit. This implies
simultaneous action on two fronts. Where
necessary, new management teams have to be
brought in, sometimes as owners, and where not
possible, as managers. Creative search for new
management teams, including the possible use
of public sector firms or private sector agents, is
necessary, as are well-structured performance incentives such as bonuses for meeting cash flow/
profit benchmarks and stock options. Of course,
if the existing promoter is capable and reliable,
they should be retained. Equally important, the
capital structure should be tailored to what is
reasonable, given the project’s situation. If the
loan is already an NPA, there is no limit to the kind
of restructuring that is possible. If standard but the
project is struggling, we have a variety of schemes
by which a more sensible capital structure can be
crafted for the project. These schemes include the
5/25, the SDR, and the S4A. A caveat is in order:
some of the current difficulties comes from an
unrealistic application by banks of a scheme so
as to postpone recognition of a loan turning NPA
rather than because of a carefully analysed move
to effect management or capital structure change.
RBI will continue monitoring to see that schemes
are used as warranted.
Medium Term Reforms
9. Moving to the medium term, in the financial
sector we need to increase efficiency through
greater entry and competition. The most
appropriate institutions will prevail when the
competitive arena is level, so we have to remove
regulatory privileges as well as impediments
wherever possible, especially those that are
biased towards some form of ownership or some
particular institutional form. A critical component
of the medium term strategy in the financial sector
will be to strengthen our public sector banks in
all aspects, including governance, cost structure,
and balance sheets. Another intent, applicable
to all financial institutions, is to strengthen
risk management, including cyber risk. RBI’s
supervision will look into all these aspects, and
also strictly enforce penalties for non-compliance
with regulations or remedial action plans.
10. We need more participation in our financial
markets to increase their size, depth, and liquidity.
Participation is best enhanced not through
subventions and subsidies but by creating
supporting frameworks and new institutions that
improve transparency, contract enforcement, and
protections for market participants against abusive
practices. Technology can be very helpful in
reducing the costs of the supportive frameworks,
and can bring hitherto excluded populations into
the financial fold.
11. Finally, as more institutions and technologies
bring more people into the financial system, we
have to make sure they are adequately informed
and protected. In 2015, RBI came out with 5
principles that banks had to follow in dealing with
customers. We asked banks to implement this
Charter of Customer Rights, and asked them to
appoint an internal ombudsman to monitor the
grievance redressal process. We now will examine
how banks are faring, and whether further
regulations are needed to strengthen consumer
protection. In particular, we will focus this year on
the issue of mis-selling, especially of insurance
products. We will also focus on enhancing our
communication with the broader public, with a view to informing them on what they need to do to
take best advantage of financial opportunities, as
well as protecting themselves. Finally, we will work
to enhance grievance redressal procedures, both
within the financial institutions, and if the customer
is still unsatisfied, subsequently through the RBI’s
ombudsman scheme. Particularly important will
be to strengthen redressal in rural areas, as well
as to the weaker sections of society.
12. Internally, the RBI will continue to increase
the specialisation of our staff, while strengthening
the performance evaluation system so as to
identify weaknesses, and the skilling system so
as to provide remedial action. For senior staff,
the accent will be on building leadership and
general management skills, while exposing them
to diverse opportunities. The broader effort will
be to enhance the incentives for continuous self-improvement
for each employee in the Bank, even
while promotions take their natural course.
13. Of course, there is far more that the RBI is
working on. I do not want to pre-empt the rest
of this report, in what is meant to be a brief
introduction to a very rich document. Thank you
for your interest in it, and more generally, in the
working of our central bank. |