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Chinese inflation, Indian NPAs and more...

Feb 22, 2008

  • China's inflation has accelerated to the quickest pace in more than 11 years after the worst snowstorms in half a century disrupted food supplies in that country. Food prices have soared 18% after blizzards paralyzed transport systems and destroyed crops. The Chinese government faces the challenge of curbing inflation without derailing the expansion of the world's fastest-growing economy. Raising interest rates when the US Federal Reserve has been cutting them may attract unwanted money from abroad into the Chinese economy. Higher borrowing costs would also be an extra drag on growth when China faces lost production from the snowstorms and the prospect of weakening export demand as a recession looms in the US.

    The Chinese government is expected to use more currency gains and curbs on bank lending to restrain price increases. It has also imposed food and energy price controls. Economists expect the government to keep raising banks' reserve requirements. The central bank has ordered lenders to set aside more deposits as reserves (alike to the Indian CRR, cash reserve ratio) on 11 occasions since the start of 2007, pushing the ratio to 15%, the highest ever.

    The IMF, which expects the Chinese economy to grow 10% this year, down from 11.4% in 2007, has urged Chinese leaders to ease exchange rate controls to address global financial imbalances and their own economic challenges. China revalued the Yuan by about 2% against the US dollar in July 2005 and has allowed it to rise by more than 13% since then.

  • Indian banks' asset quality ratios have improved significantly since FY02, but were put to test in the rising interest rate scenario as expensive consumer loans affected the borrower's repayment capacity. However, what is comforting is the fact that the vulnerable asset categories, including unsecured consumer loans, capital market exposures and real estate lending, comprise less than 10% of total loans. The median net NPA to total advances ratio (less than 10% in FY08) is therefore unlikely to rise sharply. Bankers' rights have also been strengthened and recovery from delinquent accounts is gradually improving, though an auction market for distressed assets will take a while to be established. Risk management systems are evolving in most banks although model based approaches for calculating probability of default and loss on default are likely to take three to five years to be validated. In the meantime, most large banks will implement the standardised approach for credit risk and basic indicator approach for operational risk under Basel II from March 2008.

    According to ARCIL (Asset Reconstruction Company of India Ltd.), even if Indian banks become very cautious, the best net NPA levels of 0.5% to 1% are not expected to reduce further in next 5 years. The market is likely to be swamped by US$ 1.5 bn to US$ 2 bn (about Rs 80 bn) worth of NPAs every year. Historically, there has been Rs 200 bn to 250 bn additions of gross NPAs every year for the last few years.

  • The forthcoming Union Budget is expected to strike a fine balance fiscal prudence, reform initiatives and relief measures. What and how much of this will be delivered is for all of us to see. While fiscal correction has gained a credible momentum in recent years, some of it has been achieved by reduction in public investment. Whereas a desirable shift has taken place from public to private investment in sectors essentially producing private goods and services, and there is a move toward public private partnerships in those which have both public and private goods, it is necessary to recognise that public investment is essential in sectors producing public services. Continued fiscal correction through the restructuring and reduction in subsidies, and continued attention to the mobilisation of tax revenues is necessary to enhance public sector savings that can then finance increase in all levels of public investment.

    Lags in the availability of necessary public infrastructure would also lead to inflationary pressures, and lack of competitiveness. Efficiency in the allocation and use of resources would be helped by better basic infrastructure in both rural and urban infrastructure.

    The tradeoff between relief and reform will also be a difficult one. On the one hand, trade liberalisation and tariff reforms have provided increased access to Indian companies to the best inputs available globally at competitive prices. On the other hand, the gradual opening up of the economy has led Indian companies to adjust themselves to fierce competition in world markets.

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