India may return to 8% plus GDP growth in medium term - According to CFSA

The Reserve Bank of India’s (RBI) report on financial sector assessment today indicated that the central bank is confident of the economy growing at 8% but is worried about the fiscal expansion. IT is also keen to go ahead with reforms on the corporate debt market, strengthen banks and ensure greater capital act convertibility. The financial sector assessment is an annual health check-up exercise undertaken by a country along with the International Monetary Fund and the World Bank. This was institutionalised after the Asian crisis. Following are the highlights of the latest report of the Committee on Financial Sector (CFSA).

On economy * India may return to 8% plus GDP growth trajectory in the medium term. * 8% plus GDP in medium-term depends on infrastructure, farm sector and fiscal consolidation. On external stability * Economy may face lower net foreign exchange inflow causing strain on liquidity. * Overall, India may still record net foreign exchange inflows in FY09. * Foreign exchange rate volatility will be "greatly accentuated" from mid-September onwards. * RBI and government are taking steps to meet the shortfall in rupee and foreign exchange liquidity. * The current account gap is modest despite widening trade deficit. * The current account gap is modest on high private transfer and service sector export. On banking sector * It suggested that government should exit the monitoring function of PSU banks which is unrealistic now. * The cost of recapitalisation of banks by government is relatively low versus other nations. * Capital needs are likely to increase to maintain the credit growth momentum. * Capital need from government assessed as manageable if the credit growth is within 25%. * The committee may consider merging banks on borderline of 51% with banks with high government stake. * The merger should have positive synergies and should complement regional spread. On bank margins * Banks' sub-BPLR loan have risen to 76% in March 2008 versus 27.7% in March 2002. * Banks' net interest margins have not declined sharply despite more sub-BPLR loan. * Stable NIM with high sub-BPLR loan suggests issues of transparency in operations. Aggressive banks * Credit risk on banks' capital position is relatively muted. * More reliance on volatile liabilities like bulk deposits to fund asset growth. * Higher dependence on bulk deposits leading to higher asset-liability mismatch. * RBI may consider capital charge if banks' dependence on "purchased liquidity" is high. On Statutory Liquidity Ratio (SLR) * Any cut in SLR should factor-in the pressure of government spend and fiscal gap. * SLR norm for banks helps in smooth conduct of govt borrowing programme. * SLR cut could lead to banks buying illiquid and low quality asset. On corporate bond market * Need to allow short-selling of different money market securities in a phased manner. * Allowing AAA-rated corporate bonds to be repoable should be considered. * Opening corporate debt market to FIIs may raise financial stability issues now. * Collateral like AAA paper for LAF may be explored over time. * As FCAC takes place, more disclosure needed for FIIs to invest in gilts. * Committee not in favour of term liquidity facility as existing tool is adequate. On other issues * The broader consensus is that a fuller rupee float is desirable. * The migration to fuller rupee float should be gradual. * Capital account convertibility must be concomitant with external sector balance. * There will be some reversal in low debt-equity ratio on decline in companies’ valuations. * Infrastructure deficit binding is a constraint on India’s growth. * Rapid capacity additions is key to maintaining high growth with price stability. * India could not resume fiscal correction to maintain GDP at reasonably high level. * It is necessary to return to fiscal prudence at both central and state government levels. * Development of an active corporate debt market is critical to attract private capital. * There is an urgent need to develop corporate debt market to address funding need of NBFCs. Government holding in PSU banks as on December 2008: PSU Banks Holding PNB 57.80% SBI 59.41% Indian Bank 80% BOB 53.81% Union Bank 55.43% IOB 61.23% BOI 64.47% IDBI Bank 52.68% OBC 51.09% Andhra Bank 51.55% Vijaya Bank 53.87% Dena Bank 51.19% Syndicate Bank 66.47% UCO Bank 63.59% Canara Bank 73.17% Allahabad Bank 55.23% Central Bank of India 80.20% Bank of Maharashtra 76.77% Corporation Bank 57.17% State Bank of Bikaner 75% State Bank of Mysore 92.33% State Bank of Travancore 75%