WHEN THE RESERVE Bank of India (RBI) announced an off-cycle meeting of the Monetary Policy Committee (MPC) on October 27, it was not entirely unexpected. The central bank had failed to rein in inflation for three consecutive quarters within its tolerance limit of 6% — in September, retail inflation came in at 7.41%; it was 6.63% and 7.3% for the preceding months — and according to Section 45ZN of the RBI Act (1934) it had to write a letter to the government explaining the reasons for the failure. The contents of the letter may not be made public anytime soon with governor Shaktikanta Das terming it as “privileged communication”, but he did offer a glimpse of what it may possibly contain.

“We had done our internal and scenario analysis assuming crude oil going up to $100/barrel, which was at an extremely high level. Nobody had thought crude prices would shoot up to $100/ barrel. Crude prices at that time were around $82-83/ barrel,” Das said while speaking at the Annual FIBAC Conference (organised jointly by FICCI and the Indian Banks’ Association in the first week of November). The RBI’s internal analysis had estimated inflation at around 5% for FY23 even with crude prices at $100/barrel, “but the Russia-Ukraine war changed everything,” Das had said.

The silver lining, however, is that the RBI may ease its rate hike cycle from here on; and will not try to be in-step with the U.S. Federal Reserve. The trade-off: Dollar inflows; it will have to be sacrificed even though the current level of forex reserves at $550 billion means an import cover of eight months. This is cushion enough, but is not to be used as a buffer to defend the rupee. It follows that the rupee could slide closer to 85 against the greenback by January 2023.

Other key high-frequency data also point to green shoots.

A note by Bank of Baroda’s economics research department based on the quarterly performance of 630 companies shows net sales grew at a robust 25% in Q2FY23, compared to 26.4% year-on-year (YoY). In absolute terms, net sales stood at ₹13.75 lakh crore, well above ₹8.70 lakh crore in Q2FY21.

Any which way, the numbers are remarkable given the roller-coaster ride of the last six months.

The MPC meeting on May 4 (also off-cycle) held to reassess the evolving inflation-growth dynamics and the impact of the developments after its meeting of April 6-8, 2022 flipped the interest rate plot. Overnight, the RBI privileged inflation over growth, and the MPC “voted unanimously” to hike the repo rate by 40 basis points to 4.40% with immediate effect. The committee also “decided unanimously” to remain accommodative while focusing on withdrawal to ensure inflation remains within the target going forward, while supporting growth.

Much to Cheer

It’s a view that resonates on the ground as well. “We are seeing an uptick in demand for credit for fresh capex from corporates. Most of the demand is coming from larger conglomerates and state-run entities,” says Amitabh Chaudhry, MD and CEO of Axis Bank. Working capital utilisation levels are also perking in line with higher consumer spends plus elevated commodity prices. “From a credit risk perspective, we expect the environment to be benign for the next couple of years. Corporates have been deleveraging during the past two years and their balance sheets are at their healthiest in a long time,” he adds.

Image : Photograph by Sanjay Rawat

Here’s a matter of detail: India’s bank credit as a percentage of GDP is 54.3% (as of FY22); the same for other emerging (and advanced economies) is much more. The short point: As GDP grows and credit offtake improves, the banking sector, too, will ride on it.

State Bank of India chairman, Dinesh Khara, in a media interaction after the bank’s highest-ever quarterly profit after tax of ₹13,264.62 crore (up 74% YoY) for the quarter ended September 30, remarked “that growth has come on all segments — retail, corporate, etc.” “There is a pipeline of ₹3.75 lakh crore of corporate credit, including sanctions. Overall credit growth is expected to be 14-16%, up from 10-12% guidance given at the start of the fiscal,” Khara had said.

“Can anything be more severe than the pandemic? If we can survive it, I don’t see any cause for pessimism. Just about every other economy is going through pain,” says Shyam Srinivasan, MD & CEO, The Federal Bank. His stance is that RBI’s rate hikes had been long pencilled in. And, as long as investments are on, “it will spur GDP growth, and we will start seeing traction later in the fiscal.”

That this is likely to be the trajectory was hinted in the RBI’s report on Trend and Progress of Banking in India 2020-21. It referred to the economic pick-up in Q2FY22 with the second wave of Covid-19 receding. And that, a revival in bank balance sheets, hinges around the overall economic growth. Though it did caution: “Banks would have to bolster capital positions to absorb potential slippages as well as to sustain credit flow, especially when monetary and fiscal measures unwind.”

All three material conditions have been met: Covid is largely history; bank capital positions are adequate; and unwinding of monetary and fiscal support is underway since May 4.

It’s not just banks — non-banking financial companies (NBFCs) are bullish as well.

“The last few months have seen an increase in interest rates and heightened inflation, but during the same period, demand side indicators such as GST collections, UPI transactions, e-way bills, tractor and vehicle sales, have recovered and subsequently surpassed their pre-pandemic levels”, says Rajiv Sabharwal, MD and CEO of Tata Capital. The Purchasing Managers’ Index (PMI) has remained in the expansionary zone for several months and the services industry, in particular, has seen a strong impact of the pent-up post-Covid demand.

There are deleveraged balance sheets, improvement in capacity utilisation (it has stayed above 70% in H2FY22 and Q1 FY23) and higher profitability. “This, along with a stronger banking sector with low non-performing loans, huge infrastructure and investment push from the government, is set to drive credit demand on the corporate side so long as it is accompanied by a rise in private sector investment,” adds Sabharwal.

According to Y.S. Chakravarti, MD and CEO, Shriram City Union Finance, despite rising costs, consumer spending is back with a bang in rural and urban markets. Given the robust spending trends, especially in the ongoing festival season, it appears that the economy has largely taken inflation in its stride. “Of course, a prolonged inflationary trend will eventually affect consumption, but at present, consumers are looking to make up for the lost time after challenging a few years of the pandemic, during which spending was severely restricted but is now holding good,” explains Chakravarti.

And that leads to the issue of NBFC funding which had taken a hit after the blowout at the Infrastructure Leasing & Financial Services (ILFS) and Dewan Housing Finance Corporation, as well as the hiccups on account of the regulatory changes brought on by the RBI for NBFCs, to align them more with banks.

As far as the hardening of cost of funds for NBFCs and its effect on lending rates is concerned, “it would depend on the respective NBFC’s margin earned,” says Chakravarti. Those with relatively higher margins would perhaps prefer to absorb a portion of the increased funding cost and not pass it on to borrowers. Others who operate on thinner margins may not have that luxury, and would already have hiked their lending rates. The higher cost of funds would affect deposit-accepting NBFCs since they would compete with banks for a share of the space. And in the case of Shriram City Union Finance, it’s an entirely new entity anyway — the country’s largest retail NBFC following the merger of Shriram City with Shriram Transport Finance.

Beating the Odds

The latest RBI data on sector wise credit growth till September is an eye-opener. Despite the northward movement in lending rates, YoY credit growth continues to be robust, even higher than pre-pandemic levels (September 2019). Credit to industry and services have picked up the most. “Going forward, we expect credit demand to remain steady even as RBI continues to hike rates. While the personal loan and services sector will be supported by pent-up consumption, credit to industry will be buoyed by improvement in the investment climate”, says Madan Sabnavis, chief economist, BoB Research.

Bank credit rose 16.4% YoY as of September 2022 (6.7%) and 8.2% (September 2019; pre-pandemic). While part of the reason for credit growth is the low base, demand has kicked in, which can be expected to continue till the end of the festival season. And as India enters into a season of polls, demand for all kinds of support services, and the consequent consumption it triggers, will ripple through the economy.

This is despite the weighted average lending rate (WALR) on outstanding rupee loans moving up. For state-run banks, WALR is up 43 bps to 8.65%; for private banks, it was a tad higher at 52 bps (10.17%). For scheduled commercial banks it was up 49 bps at 9.23%. The general sense emerging is that we can live with a rate hike, or two more — it is up 190 bps since May 4.

So how is the plot going to unfold as we move ahead?

The clue could lie in the MPC meeting of September 30. While most MPC members were for front-loading a 50-bps rate hike, two external members — Jayant Varma and Ashima Goyal — were for a pause. Varma took the view that monetary policy “acts with lags” and hence, it is necessary to assess the impact of monetary policy action before embarking on further rate hikes to avoid the “risk of overshooting the repo rate needed to achieve price stability”. Goyal observed that “over-reaction” to monetary policy can be harmful and advocated “tapering of action”. Now, it’s true that the duo’s stance hinges on a more benign inflation forecast from RBI.

As for inflation and rate hikes, it is worth recalling that the off-cycle MPC meeting in November (scheduled a day after the Fed meet) gave rise to speculation that the RBI may further raise rates. Nothing of that sort happened. Nor were the off-cycle MPC meetings in March 2020 or May 2002 followed by press releases. Is something cooking? The RBI in its report on Currency & Finance (2020-21) noted that in the case of India, failure may be redefined as inflation overshooting or undershooting the upper or lower tolerance bands around the target for four consecutive quarters instead of the current three!

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