India Insight:Meeting with RBI –banking reform is key for monetary transmission

Banking sector is grappling with balance sheet repairs: The system-widegross NPAs plus restructured assets ratio remains high at 11.5% in FY16.

The RBI and government have taken a number of initiatives to clean up thebank’s balance sheet. While it is imperative to stick to the Mar-17 deadline forbanks to clean up their books, the choice of RBI governor might have abearing on this process initiated by Dr Rajan (whose term ends in the firstweek of Sept-16). While the ongoing clean-up of banks’ balance sheets willhurt profitability in the short term, it will support economic recovery in a moresustainable way.

Credit disbursements are happening: The general view was that the creditdisbursements are taking place even as the growth in outstanding loan bookhas only been modest (~10%YoY). The outstanding loan book has alsoshrunken as banks have converted part of the exposure to investments due topower sector reforms under UDAY (the government's scheme to addresselectricity distribution companies (DISCOMs) finances). While the workingcapital requirement of companies is being met by banks, the lack ofinvestment demand on still low capacity utilisation and stress in the bankingsystem is constraining overall credit growth.

Monetary policy stance remains accommodative: The official mentionedthat there is a marginal negative output gap (difference between actual outputand potential output) in the economy though the gap is closing slowly. Thecurrent repo rate (6.5%) is actually lower than the required nominal interestrates (of ~7% computed using an average inflation of ~5.5% and positive realinterest rates of ~1.5% to incentivise households to put money into financialsavings) indicating that the policy stance remains accommodative.

Setting up of monetary policy committee (MPC): The official mentionedthat the government is trying its best to expedite the process towards theconstitution of a Monetary Policy Committee (MPC) so that the policy raterequired to achieve the inflation target is determined by a majority vote.

Out of the six members of MPC, three members will be from the RBIincluding the Governor, Deputy Governor; and one officer and the rest willbe appointed by the Central Government, on the recommendations of asearch-cum-selection committee. On their part, RBI has already giventheir suggestions on what they were required to do.

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