Economic Survey Vol.2 Ch.4: Monetary Management and Financial Intermediation

MONETARY DEVELOPMENTS DURING 2019-20

• Monetary policy during 2019-20 was conducted under the revised statutory framework, which became effective from June 27, 2016. As on the end of January 2020, five meetings of the Monetary Policy Committee (MPC) have been held in the financial year 2019-20.
• The repo rate was reduced by 110 basis points (bps) from 6.25 % in April 2019 to 5.15 % in October 2019. MPC’s decision was guided by low inflation and the need to strengthen domestic growth by spurring private investment in the economy.

Later on, MPC decided to keep the repo rate unchanged due to reasons like

• The rising consumer price inflation.
• MPC's intention to wait until effective monetary policy transmission happens.
• The real GDP projections were revised downwards to 5 % for 2019-20 due to:
• Various high-frequency indicators along with surveys conducted by the Reserve Bank indicated a weakening of both domestic and external demand conditions

Liquidity Conditions and its Management

Current Status:

Systemic liquidity in 2019-20 has been largely in surplus since June 2019 due too. The increased spending by the government, net forex purchases by the RBI, reduction in Statutory Liquidity Ratio (SLR) and return of currency to the banking system combined with the Open Market Operations (OMO) purchase auctions. Other factors creating surplus liquidity are moderation in currency demand after two years of high demand following demonetisation. 

Developments in the G-Sec Market

• Initially yield on G-Sec hardened marginally on account of rise in crude oil prices.
• Thereafter, it largely followed a downward trend which may be attributed to various reasons:  Change in monetary policy stance of the U.S. Fed (on global growth concerns and ongoing trade tensions).
  • Easing of liquidity condition of the banking system.
  • Consecutive policy rate cuts by the RBI along with the change of stance from neutral to accommodative.
  • Benign crude oil prices aided the sentiment.
  • Transfer of RBI surplus to the Government.
  • Significant and sustained surplus liquidity.
  • “Special Open Market Operation” (purchase of long term securities and the simultaneous sale of short term securities) by Reserve Bank of India also helped bring down the yield slightly on 10 years G-Secs.

Developments in the Banking sector:

•  
• Gross Non-Performing Advances (GNPA) ratio (i.e., GNPAs as a percentage of Gross Advances) of Scheduled Commercial Banks (SCBs) remained flat at  9.3% at the end of September 2019, as was at end March 2019.
• Restructured Standard Advances (RSA) ratio of SCBs remained unchanged at 0.4% during the same period.
• Stressed Advances (SA) ratio of SCBs also remained flat at 9.7%.
• GNPA ratio of Public Sector Banks (PSBs) was unchanged at 12.3%.
• SA ratios of PSBs increased from 12.7 to 12.9%.
• Capital to risk-weighted asset ratio (CRAR) of SCBs increased from  14.3 to 15.1%, largely due to improvement in CRAR of PSBs.
• Many PSBs have continued to record negative profitability ratios.

Monetary Transmission: Transmission of monetary transmission has been weak in 2019 on all three accounts: Rate Structure, Quantity of Credit, and Term Structure.

• Rate Structure: The Weighted Average Lending Rate (WALR) of SCBs has not declined at all in 2019 despite the reduction of repo rate by 135  bps since January 2019.
• The credit spread (the difference between repo rate and WALR) is at the highest level in this decade. This suggests that there has been no transmission of the cut in repo rate to lending rates of the banks in 2019.
• Term structure: RBI’s monetary easing and Liquidity Adjustment  Facility (LAF) has had some impact on short term interest rates.  However, the same has not been the case for longer-term maturities.

Credit growth:

• Despite a decrease in policy rates, credit growth in the economy has been declining since the beginning of this year.
• Credit growth moderated across all major segments of non-food credit, except personal loans, which continued to grow at a steady pace.
• Credit growth to the services sector decelerated sharply.
• Credit growth in the industry has also been very low in recent months.
• The main contributor to this slowdown has been a negative growth of credit to Micro, Small and Medium Enterprises (MSME) and the Textile sector.

Non-Banking Financial Sector

Current Status:

• The growth of loans from NBFCs declined but the balance sheet of the NBFC sector grew significantly.
• The sector also witnessed liquidity stress.
• Sources of funding of NBFCs: Bank borrowings and market borrowings increased while the deployment of credit by mutual funds to NBFCs has been contracting. Among the instruments of market borrowing, the share of Commercial Papers decreased while the share of Non-Convertible Debentures (NCDs) increased.
• The Capital to risk-weighted assets ratio (CRAR) of the NBFC sector remained at 19.5 % as against the regulatory requirement of 15 %.
• Both the gross NPAs ratio and net NPAs ratio of NBFC sector increased.
• The Return on Assets (RoA) and the Return on Equity (RoE) has declined in the previous year

Developments in Capital market:

• Primary Market Resource Mobilisation through public and rights issues had declined as compared to 2017-18. Public issues (equity) decreased. Rights issues (equity) increased sharply.
• Public Issue (Debt securities) declined significantly. Primary Market Resource Mobilisation through Private Placements was a preferred route to gear up the capital by Indian corporates. There was a net inflow into the mutual funds’ industry during April- December 2019.
• There was net inflow on account of Foreign Portfolio Investors  (FPIs) in the Indian capital market during April-December 2019, as compared to net outflows in the previous corresponding period. It stood at US$ 259.5 billion as on December 31, 2019.

Insurance Sector:

• The potential and performance of the insurance sector are generally assessed on the basis of two parameters, viz., insurance penetration and insurance density.
• The insurance density in India which was US$ 11.5 in 2001 has increased to US$ 74 in 2018 (Life- US$ 55 and Non-Life -US$ 19).
• Penetration for Life insurance has declined from 2011, whereas for the non-life insurance it has increased consistently. It is 2.74 % for Life Insurance and 0.97 % for Non-Life insurance in 2018.
• Globally insurance penetration and density were 3.31 % and US$ 370 for the life segment and, 2.78 % and US$ 312 for the non-life segment respectively in 2018.

Insolvency and Bankruptcy Code: Important Developments

• Three years into about 743 out of 2,542 corporates who have initiated a corporate insolvency resolution process have completed the process.
• 41.2 % of the cases admitted by NCLT for CIRP are in the manufacturing sector followed by 19 % in Real Estate, Renting and Business Activities sector.
• The resolution under IBC has been much higher as compared to other processes