Shaktikanta Das: Winning in uncertain times - the Indian experience
Inaugural speech by Mr Shaktikanta Das, Governor of the Reserve Bank of India, at the
Financial Institution Benchmarking and Calibration (FIBAC) 2023 Conference, jointly
organised by the Federation of Indian Chambers of Commerce and Industry (FICCI)
and the Indian Banks' Association (IBA), Mumbai, 22 November 2023.
* * *
I am thankful to FICCI and IBA for once again inviting me to this FIBAC Conference.1
As momentous changes are taking place in the financial and business landscape,
events like this provide an opportunity to industry leaders, bankers and policymakers to
deliberate on issues of our times and crystallise our thoughts for future guidance. Today
the world is grappling with an unending string of challenges since 2020. Geopolitical
conflicts, geo-economic fragmentations, volatile commodity prices, uncertainty in
trajectory of monetary policies and their macro-financial implications, increasing
frequency and ferocity of climate shocks, all these prevailing together, present a very
complicated or should I say, deadly mix of challenges. Historical regularities are looking
improbable and policymakers are being put to test. In this backdrop, the theme of
today's conference - "winning in uncertain times" - aptly captures the long-standing
quest of humanity to make progress against all odds and challenges. I am an optimist
and I remain confident that we can work together and navigate through this stormy
weather.
In tune with the theme of the conference, I would like to touch upon the Reserve Bank's
policies and actions in the last one and half years to maintain macroeconomic stability. I
would then proceed to talk about India's growth drivers and emerging opportunities that
can be harnessed to enhance India's potential growth. In the end, I propose to highlight
certain key issues which merit the attention of banks, NBFCs, financial sector entities
and even businesses.
The Conduct of Monetary Policy in the Year Gone By
The monetary policy actions of the Reserve Bank over the last one and half years
consisting of prioritisation of inflation ahead of growth, narrowing the Liquidity
Adjustment Facility (LAF) corridor, increasing the policy repo rate by 250 bps, draining
out excess liquidity - together with supply side measures by the Government - have
facilitated significant softening of headline inflation to 4.9 per cent in October 2023. The
moderation in core inflation, in particular, is noteworthy.
There is also recent evidence of household inflation expectations becoming more
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anchored. Headline inflation, however, remains vulnerable to recurring and
overlapping food price shocks coming from global factors and adverse weather events.
The frequency and intensity of such shocks have increased in recent period. Monetary
policy in such a scenario needs to remain watchful and actively disinflationary while
supporting growth.
I must add that our actions over the past one and a half years did not engender any
financial stability risks as witnessed in some advanced economies in the early part of
2023. This may be attributed to the regulatory requirements prescribed by the Reserve
Bank which banks are expected to follow to manage their interest rate risk. These
requirements act as safeguards for future stress that may arise when the upturn of the
interest rate cycle takes place.3
On the exchange rate front, the Indian rupee (INR) has exhibited low volatility and
orderly movements relative to peers despite elevated US treasury yields and a stronger
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US dollar. Movements in the INR are consistent with the strength of the underlying
macro-fundamentals and the reassuring availability of buffers.
Growth Drivers and Opportunities
As many business leaders are present here, let me now dwell upon India's growth
drivers and the opportunities that lie ahead. The Indian economy rebounded strongly
from the COVID-induced contraction of 5.8 per cent in 2020-21 to a growth of 9.1 per
cent in 2021-22 and 7.2 per cent in 2022-23. India's real GDP is expected to grow by
6.5 per cent in both 2023-24 and 2024-25, making it one of the fastest growing large
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economies in the world. In fact, India is already the third largest economy in the world
in terms of purchasing power parity (PPP). Despite global slowdown, the Indian
economy has remained resilient and continued to grow due to its higher reliance on
domestic demand which enabled the economy to weather multiple global headwinds.
Although India has made rapid strides in external openness through trade and financial
channels and gained competitiveness, its dependence on domestic demand provides a
cushion against external shocks. At the same time, various structural reforms
implemented in areas of banking, taxation, inflation management and manufacturing
sector, etc. over the last few years, have laid the foundation for sustainable and higher
growth.
We have moved from an era of twin deficit and twin balance sheet stress to the current
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period of twin balance sheet advantage. While balance sheets of banks witnessed
significant improvement on the back of improved asset quality and profitability,
corporates also display stronger financials, having deleveraged their balance sheets.
The improved health of the banks and corporates is also reflected in their recent second
quarter results of 2023-24. The corporate performance parameters based on 1501
listed non-government non-financial companies suggest strong growth in profitability
and staff costs in Q2:2023-24. The Reserve Bank's latest industrial outlook survey
indicates that business outlook further improved with manufacturing firms being
optimistic about demand condition in Q3:2023-34. Capacity utilisation (CU) in the
manufacturing sector, on a seasonally adjusted basis, continues to trend up, which
augurs well for investment activity. The continued thrust on capex by the government is
also favourable for investment activity. It is now for corporates and other businesses to
evaluate the current situation and future potential of India and move forward.
On the supply side, the agriculture sector has kept good momentum over the last few
years and its performance is expected to remain stable during 2023-24 despite uneven
south-west monsoon and lower kharif production. Production of foodgrains as well as
horticulture have reached record levels year after year. The diversification of exports,
both in terms of products and destinations, is enhancing the economy's capacity to
withstand shocks. The agricultural sector continues to provide employment to a large
part of our workforce.
There are, however, several challenges relating to productivity gaps, water usage and
irrigation facilities, shifting consumer preferences and sudden weather events. All these
require heavy investments in infrastructure and innovation to modernise the agricultural
sector and realise its true potential for achieving higher productivity; more efficient
access to markets; maximising farmers' income; and increasing its contribution to GDP.
As a nation we must find a way of carrying out certain reforms, especially in the area of
agricultural marketing and the connected value chains. These reforms are critical not
only for sustained high growth but also for durable price stability and to mitigate the
frequency and intensity of food price shocks. It is important that private sector comes
forward in a big way and becomes a crucial partner in this journey. There are
opportunities for the private sector to invest in strategic areas of agriculture and allied
activities such as supply chains; food processing involving variety of fruits, vegetables
and food grains; scaling up dairy, poultry and fishing; and creating marketing
infrastructure. Private sector can accelerate farm-firm ( i.e., agri-industry) linkage and
improve the efficiency of the entire value chain right up to the end customer.
As regards the manufacturing sector, even as its share in the economy has been
around 17-18 per cent over the years, it has potential to accelerate its contribution to
growth and employment. India's demographic advantage with its young labour force
also presents a unique opportunity to become a key player in global manufacturing. It is
important for us to be part of the global supply chains which are undergoing
realignments in the fragmented global economy. Initiatives like the production-linked
incentive (PLI) scheme create conducive conditions to enhance the share of
manufacturing in our GDP. Sectors such as smart phones, large-scale electronics,
pharma, food processing, auto and auto components have recorded good performance
under the PLI scheme. There is also huge potential in emerging areas such as
aerospace and defence, low-carbon technologies, electric vehicles and
semiconductors. Our efforts towards building robust public digital infrastructure, which is
fostering digitisation and ease of doing transactions across the spectrum, will continue
to provide strong fillip to technology adoption and productivity.
At present, the services sector contributes the largest share in India's GDP and remains
an anchor of overall growth. The Indian services sector is fast adopting new
technologies such as artificial intelligence, internet of things, cloud computing and data
analytics to improve service delivery, reach, and competitiveness. The newly emerging
start-ups are also largely concentrated in the services sector. There is a steady shift
from low-skill consumer-oriented services towards more technology-enabled business
services. Indeed, there is a case for Indian businesses to recognise this undercurrent
and work towards upscaling their activities to meet the external demand in this sector.
In fact, India commands a strong external position, thanks to the strength of our
services exports, which have largely remained resilient. They have supported India's
current account deficit, even as merchandise exports have been under pressure in the
face of weakening global demand. The current account deficit to GDP ratio has
remained under 2 per cent for almost 10 years. India's services exports are diversifying
from information technology (IT) related services to other professional services such as
business development, research and development, professional management,
accountancy and legal services.
Overall, India's growth journey with active participation of manufacturing and services
sectors and dependence on domestic demand could be self-fulfilling in the years to
come.
Some Reflections on Financial Sector Issues
Let me now turn to the financial sector. As the Indian economy strives to grow in an
evolving and uncertain global environment, it is imperative that our financial sector
remains strong. The Indian banking system continues to be resilient, backed by
improved capital ratios, asset quality and robust earnings growth. The financial
indicators of non-banking financial companies (NBFCs) are also in line with that of the
banking system as per the latest available data. While banks and NBFCs are showing
good performance now, sustaining it requires concerted efforts. In good times like
these, banks and NBFCs need to reflect and introspect as to where potential risks could
possibly originate. Now is the time for them to further strengthen their risk management
practices and build additional buffers to face the situation, if the business cycle turns
adverse.
On our part, the Reserve Bank of India has significantly strengthened its regulation and
the supervision of banks, NBFCs and other regulated entities in recent years. We have
also very recently announced a few macro prudential measures in the overall interest of
sustainability. These measures are pre-emptive in nature. They are calibrated and
targeted. It may be relevant to note that major growth drivers like loans for housing,
vehicles and MSME sector have been excluded from these measures. We continue to
focus on strengthening governance and assurance functions, ensuring effective risk
management and robust lending practices. We are monitoring the supervised entities
through various onsite and off-site tools, stress testing, vulnerability assessments,
thematic studies, data dump analysis, etc. as part of our proactive and forward-looking
supervisory approach. Banks, NBFCs and other financial entities must continue to do
stress testing of their books. In fact, there is a strong case for companies in the real
sector also to stress test their businesses and balance sheets. Many of them may
already be doing so, but it would be desirable that many more also do this.
At the current juncture there may not be any immediate cause for worry, but to remain
on top of things, Banks and NBFCs would be well advised to take certain precautionary
measures. In this context, I would like to highlight four points.
First, while credit growth is accelerating in the current period, banks and NBFCs may
take due care to ensure that credit growth at the overall, sectoral and sub-sectoral
levels remain sustainable and all forms of exuberance are avoided. Expansion of the
credit portfolio itself and pricing of the same should be in sync with the risks envisaged.
Banks and NBFCs also need to further strengthen their asset liability management.
They may give greater attention to their liabilities side. In certain cases, we have
observed increased reliance on high cost short term bulk deposits while the tenure of
the loans, both in retail and corporate loans, is getting elongated.
Second, given the increasing importance of non-bank financial companies (NBFCs) in
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the financial system, the increasing interconnectedness between banks and non-banks
merits close attention. NBFCs are large net borrowers of funds from the financial
system, with their exposure from the banks being the highest. Banks are also one of the
key subscribers to the debentures and commercial papers issued by NBFCs. NBFCs
also maintain borrowing relationships with multiple banks simultaneously. Needless to
state that such concentrated linkages may create a contagion risk. Though the banks
are well capitalised, they must constantly evaluate their exposure to NBFCs and the
exposure of individual NBFCs to multiple banks. The NBFCs on their part should focus
on broad basing their funding sources and reducing over-dependence on bank funding.
Third, microfinance has emerged as an important financial conduit to foster financial
inclusion. As Micro Finance Institutions (MFIs) are catering to the marginalised
clientele, they have to bear in mind the affordability and repayment capacity of the
borrowers. Though the interest rates are deregulated, certain NBFCs-MFIs appear to
be enjoying relatively higher net interest margins. It is indeed for micro finance lenders
to ensure that the flexibility provided to them in setting interest rates is used judiciously.
They are expected to ensure that interest rates are transparent and not usurious.
Fourth, the increased collaboration of Banks and NBFCs with FinTechs is facilitating
introduction of innovative products and services and new business models. Digital
technologies are offering a powerful medium to access banking and financial services.
This has also brought down the operational costs and helped in enhancing the reach of
financial services providers. An important aspect that merits attention in this context is
with regard to model-based lending through analytics. Banks and NBFCs need to be
careful in relying solely on pre-set algorithms as assumptions based on which the
models are operated. These models should be robust and tested and re-tested
periodically. They may require to be calibrated and re-calibrated from time to time
based on the changing contours of the financial ecosystem and fresh information. It is
necessary to be watchful of any undue risk build up in the system due to information
gaps in these models, which may cause dilution of underwriting standards.
Concluding Observations
We are living in highly uncertain times in an interconnected world. New risks are
emerging from time to time. New sources of risk are also coming up. In such a scenario,
building up further on resilience would be the best insurance against shocks and
uncertainties. This holds good for all businesses and financial entities. As I see many
banking and corporate leaders in the audience, let me also stress that new
opportunities are knocking at our doors. It is for us to capitalise on them. There has to
greater focus on investment in capacity building, skilling of human resources and
adoption of newer technology by all players. The international confidence on India's
prospects is at a new high; it is an opportune time to make this India's moment and
work towards strong, sustainable and inclusive growth.
Thank you, Namaskar!
Federation of Indian Chambers of Commerce and Industry (FICCI) and Indian Banks
Association (IBA).
2
Mooring of household inflation expectations has been underway since September
2022. Inflation expectations for three months ahead fell by 90 bps from 10.0 per cent
(July 2023 round) to 9.1 per cent (September 2023 round) and by 40 bps for one year
ahead from 10.3 per cent (July 2023 round) to 9.9 per cent (September 2023 round).
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The capital and liquidity requirements in India are uniformly applied to all the
scheduled commercial banks, irrespective of their asset size and exposure. Investment
fluctuation reserves (IFR) have also been created in the banks. Valuation guidelines on
available for sale (AFS) category of investment are stringent and follow a conservative
approach.
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As of November 20, 2023, the INR had depreciated (on calendar year basis) by 0.7
per cent against the dollar, performing well when compared to its EME peers including
the Chinese yuan, the Thailand baht, the Vietnamese dong, Argentine peso and the
Malaysian ringgit. It had appreciated by 12.4 per cent against the Japanese yen, while it
depreciated by 2.7 per cent against Euro and by 3.7 per cent against the UK pound.
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According to the International Monetary Fund (IMF), India will become the
thirdlargest economy before 2030, with its GDP projected to surpass both Japan and
Germany by 2026 and 2027, respectively. India is already the third largest economy in
the world in terms of purchasing power parity (PPP) (with a share of 7 per cent of global
GDP) after China and the USA (Source: IMF, World Economic Outlook (WEO)
database).
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While twin deficit refers to the situation when an economy suffers from both the fiscal
deficit and the current account deficit, twin balance sheet stress is a scenario where
banks are under severe stress and the corporates are overleveraged to the extent that
they cannot repay their loans.
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The widening presence of NBFCs is reflected in their increasing credit to GDP ratio -
from 8.6 per cent to 12.3 per cent between 2012-13 and 2021-22.