Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Financial instability is in the air - Outside View by S.S. TARAPORE
Financial instability is in the air

We should be prepared for greater volatility in world markets and reversal of capital flows

The Reserve Bank of India's Financial Stability Report No11, June 25, 2015, is not one to attract media attention for a day and then be consigned to the archives. It is a report with a serious message.

Governor Raghuram G Rajan, in a prescient foreword, cautions that the US Fed's "taper tantrum" might be only one of a series of such tantrums in the global financial markets. He says that we in India have to be vigilant about the spillover effects. The FSR envisages an overall regulatory framework for the entire system which would be institution-neutral, ownership-neutral and technology-neutral.

The report highlights that eight years after the onset of the financial crisis, the global economy is still in search of a sustainable growth path. The report is concerned that there is not much monetary-fiscal space, given the near zero interest rates and the ballooning public debt in leading countries.

Fears of low growth

Right from the onset of the global crisis in 2008, this columnist has been expressing fears that the global economy could be experiencing a long-term Kondratiev wave which could imply a very long period of low global growth. Admittedly, there are very few, or perhaps no takers for this theory. My own fear is not that my assessment is wrong but rather the consequences for India if perchance I am right. The RBI report does well to caution that we need to be prepared for the risk of greater volatility in global financial markets and reversal of financial flows.

While the latest official estimate for overall growth of the Indian economy is 7.3 per cent in 2014-15, it appears to be at odds with low credit off-take, low flow of resources to the commercial sector, low capacity utilisation and muted corporate performance. While utilising the policy space, the RBI has frontloaded monetary accommodation by reducing the policy repo rate by 0.75 percentage points during January-June 2015. Gross domestic savings fell to 30 per cent of gross national disposable income in 2013-14, largely because of a fall in household sector savings.

Notwithstanding this incontrovertible fact, the government, the corporate sector and prominent economists and analysts all seem to make shrill noises that interest rates in India need to be reduced. Advocates of a soft monetary policy need to appreciate that in India there is a shortage of savings relative to investment opportunities and, as such, reducing interest rates to trigger growth is clearly a wrong policy prescription.

Monetary brakes

It is unfortunate that Indian policymakers and opinion-makers are totally unaware of FA Hayek's fundamental contribution in Prices and Production and Other Works (1931), wherein at the upper turning point of the cycle there is a shortage of savings and there is a resort to forced savings via created money.

At each round of production the created money has to be increased. The central bank applies the brakes as inflation looms large, and this triggers the downturn of the cycle. Invariably, monetary policy action is deferred till the upper turning point of the cycle is passed and this merely accelerates the downturn. Thus, it is important to apply the monetary brakes before the upper turning point of the cycle is reached.

The FSR concludes that India's external vulnerability has reduced considerably due to the fall in the balance of payments, current account deficit (CAD), and improved capital inflows. The risks in the ensuing period are possibilities of capital outflows, uncertainties of the crude oil price, lower exports and adverse movements in the exchange rate.

Deposit growth of scheduled commercial banks (SCBs) fell from a year-on-year increase of 12.9 per cent in September 2014 to 10.7 per cent in March 2015; credit expansion declined from 10.0 per cent to 9.7 per cent. What is of greater concern is that credit expansion of public sector banks (PSB) fell from 8.0 per cent in September 2014 to 7.1 per cent in March 2015.

The capital to risk-weighted assets ratio (CRAR) of PSBs fell by 1.8 percentage points between March 2011 and March 2015. The gross non-performing assets of SCBs as a percentage of gross advances amounted to 4.6 per cent. What is more alarming is that the PSBs' stressed assets amounted to 13.5 per cent of total advances. It is increasingly being recognised that stressed assets are nothing other than NPAs swept under the carpet.

This would be contested by officials but ultimately we have to call a spade a spade. Infrastructure accounts for 30 per cent of stressed assets and the government's pressure on PSBs to provide more funds for infrastructure point to the possibility of NPAs increasing.

Deposit insurance

At the end of March 2015 deposit insurance covered 92 per cent of the total number of accounts, and 30 per cent of the total amount of deposits; this conforms to international norms. The report claims that banks which are under direction will eventually go into liquidation and as such the outgo of funds from the deposit insurance agency is likely to be insignificant.

The optimism in the report is unwarranted. The experience is that since the 1960 failure of the Palai Central Bank, no SCB has been allowed to fail. The historical record is that the deposit insurance agency has had to be bailed out by the RBI.

The report is an in-depth analysis of the Indian financial system and this short column can in no way do justice to its technical competence and great perspicacity. Nonetheless, it bears mentioning that when a major crisis hits the financial system, the system invariably collapses despite all the safeguards.

 Please Note: This article was first published in The Hindu Business Line on July 10, 2015.

This column, Maverick View is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Freepress Journal, is titled Common Voice.

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.


Equitymaster requests your view! Post a comment on "Financial instability is in the air". Click here!


More Views on News

How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

Jun 10, 2017

Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

How To Read Your Mutual Fund Account Statement Correctly (Outside View)

Aug 17, 2017

PersonalFN simplifies the mutual fund account statement for you.

This Small Cap Can Drive Chinese Players Out of India (and Make a Fortune in the Process) (The 5 Minute Wrapup)

Aug 17, 2017

A small-cap Indian company with high-return potential and blue-chip-like stability is set to supplant the Chinese players in this niche segment.

Which Gods Will Bring Down the US Empire? (Vivek Kaul's Diary)

Aug 17, 2017

Mr Trump is in the White House and the gods are in their heavens; what's not to like?

Will They Haul Off Trump's Statue, Too? (Vivek Kaul's Diary)

Aug 16, 2017

All across the country, the old gods become devils. New, gluten-free gods take their places...

More Views on News

Most Popular

Demonetisation Barely Made Any Difference to Tax Collections(Vivek Kaul's Diary)

Aug 7, 2017

The data tells us quite a different story from the one the government is trying to project.

Proxy Plays: A Smart Way to Bet on 'Off Limits' Companies(The 5 Minute Wrapup)

Aug 4, 2017

The small-cap space is full of small players that are clear proxies to great growth stories and Indian megatrends.

Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

Aug 8, 2017

Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

Signs of Life in the India VIX(Daily Profit Hunter)

Aug 12, 2017

The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

7 Financial Gifts For Your Sister This Raksha Bandhan(Outside View)

Aug 7, 2017

Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...


Become A Smarter Investor In
Just 5 Minutes

Multibagger Stocks Guide 2017
Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
We will never sell or rent your email id.
Please read our Terms


Aug 17, 2017 (Close)