Headwinds from the global slowdown and the transient impact of demonetisation notwithstanding, the Indian economy demonstrated resilience in 2016-17, marked by moderate expansion and macroeconomic stability – low inflation, and improvement in current account and fiscal deficits. Financial markets priced in global and domestic shocks and volatility ebbed, with excess liquidity conditions induced by demonetisation persisting through the second half of the year. In this milieu, the outlook for growth in 2017-18 has brightened, with the likelihood of another favourable monsoon and the implementation of major policy reforms – led by the introduction of the Goods and Services Tax (GST) from July 1, 2017 – that would help to unlock bottlenecks to growth.
Assessment for the year 2016-17: In 2016-17, Gross Domestic Product (GDP) growth moderated due to slowdown in gross capital formation as waning business confidence and flagging entrepreneurial energies took their toll on the appetite for new investment. On the other hand, both government and private consumption accelerated and held up aggregate demand. While the turnaround in the growth of agriculture paved the way for a pick-up in rural demand, urban demand remained resilient due to hikes in salary, wages and pensions of the central government employees. There has also been an improvement in households’ financial savings, post demonetisation.
On the production side, agriculture and allied activities rebounded sharply in 2016-17. As the infrastructure sector is widely perceived to hold the key to revival of growth, top priority was accorded to addressing environmental clearances, land acquisition issues and other. structural bottlenecks associated with project implementation, which led to a reduction in the number of stalled projects and cost overruns in central sector infrastructure projects during 2016- 17. Inflation picked up during the first four months of 2016-17 driven by an upsurge in food prices, outweighing favourable base effects.
The asset quality of the banking sector continued to be a concern during 2016-17. In the aftermath of the asset quality review (AQR) undertaken by the Reserve Bank beginning July 2015 and concomitantly with better recognition of non-performing assets (NPAs), the asset quality of banks, particularly the PSBs, deteriorated sharply. As the banking sector struggled with the sizeable volume of NPAs, the Reserve Bank continued its efforts to fortify the regulatory framework through significant policy interventions for improving the banking system’s ability to deal with distress
Post demonetisation, the pace of monetary transmission from the policy repo rate to banks’ lending rates accelerated significantly, aided by the increase in the share of low cost current account and saving account (CASA) deposits in bank funding. However, the transmission to actual lending rates was uneven across sectors, reflecting sector-specific credit risk dynamics. During 2016-17, the benchmark Indian equity indices, viz., BSE Sensex and Nifty 50 increased by 16.9 per cent and 18.5 per cent, respectively, as against some contraction in the previous year. The stock market gained on account of optimism over the Union Budget proposals, passage of the GST Bill, favourable monsoon, expectations of steady progress of economic reforms, better macroeconomic data, higher than expected Q3 earnings of companies and huge buying by institutional investors amid positive cues from global equity markets.
Highlights of the RBI’s Annual Report 2016-17
Economic Review: In the midst of global slowdown accentuated by the vicissitudes of financial markets and the transient impact of demonetisation, the Indian economy turned out resilient, marked by both internal and external stability. While economic growth moderated in 2016-17, there were visible signs of improvement in macroeconomic fundamentals – low inflation, and modest current account deficit and fiscal deficit. Going forward, even as the recent launch of the Goods and Services Tax (GST) gains traction across the country, strengthening fiscal consolidation, particularly at the sub-national level; reviving bank credit, and bringing investment back on rails, remain a challenge.
Monetary policy operations: Fundamental institutional changes impacted monetary policy in India following the amendment to the Reserve Bank of India (RBI) Act, 1934, effected on June 27, 2016. The policy rate was reduced by 50 bps during 2016-17 and the policy stance shifted from accommodative to neutral in February 2017. Even as inflation undershot the target of 5 per cent set for Q4 of 2016-17, monetary policy operations had to contend with massive surplus liquidity conditions, necessitating a mix of conventional and unconventional instruments of liquidity management. In spite of faster transmission of policy rate changes to marginal cost of funds based lending rates (MCLRs), pass-through to actual lending rates remained incomplete.
Credit delivery and Financial inclusion: The Reserve Bank placed greater emphasis on effective credit delivery during the year by intensifying its ongoing efforts under the financial inclusion plans as well as adopting innovative approaches in expanding credit and spreading financial literacy. The major thrust was on operationalising a market mechanism for enhancing priority sector credit, strengthening the business correspondent (BC) model through BC registry and certification to promote financial inclusion, and enhancing financial literacy through a digital focus in literacy camps, experimenting with ground level camps, capacity building of financial literacy counsellors and observation of a financial literacy week. Work is also underway for the formulation of a National Strategy for Financial Inclusion.
Financial markets and foreign exchange management: During 2016-17, the Reserve Bank undertook a number of measures for developing various segments of the financial markets. In the money market, the Reserve Bank undertook proactive liquidity management operations, with a view to aligning money market rates with the policy rate for better transmission of monetary policy. Orderly conditions were maintained in the spot, forward and futures segments of the forex market, alongside further liberalisation of the capital account and rationalisation of the reporting requirements to promote ease of doing business.
Regulation, supervision and financial stability: During 2016-17, the Indian banking sector had to cope with the concerns about deteriorating asset quality, on the one hand, and a sharp decline in credit growth, on the other, while supporting the government in its initiatives to further reach out to the public and in promoting digitalisation of the modes of payments in the economy. The branch authorisation policy was revised to harmonise the treatment of different forms of bank presence for the purpose of opening banking outlets in under-served areas. Empowered by requisite legislative provisions put in place by the government, the Reserve Bank focused on strengthening the institutional framework to address asset quality concerns by improving the recovery process and the early response mechanism.
Having gained experience with the licensing of small finance and payments banks, the Reserve Bank explored the scope of introducing more differentiated banks such as ‘wholesale and long-term finance banks’ and also examined the regulatory challenges posed by innovations by Fin Tech entities in the financial landscape. Apart from focusing on the supervision of financial conglomerates and early response to asset quality deterioration, the Reserve Bank formalised a framework for taking enforcement action against banks for non-compliance with guidelines and instructions issued by it. For ensuring timely and effective redressal of customer grievances in non-banking financial companies (NBFCs), the Reserve Bank proposes to formulate an appropriate Ombudsman Scheme for NBFCs.
Public Debt Management: The Reserve Bank successfully managed the market borrowing requirements of the central and state governments during 2016-17 in an orderly manner in the face of multiple challenges such as glide path for reduction in Held to Maturity(HTM) category and Statutory Liquidity Ratio(SLR), supply concerns over increased state government issuances, issuances of UDAY bonds and global uncertainties. The borrowing programme was conducted in line with the debt management strategy of low cost, risk mitigation and market development while factoring in domestic as well as global economic and financial conditions.
Currency management: Currency management during 2016-17 was geared towards managing the process of demonetisation of specified bank notes effected in early November 2016 and the subsequent remonetisation by making available adequate quantity of banknotes to meet the legitimate demand of the public in the shortest possible time. Sustained efforts continued to be made towards indigenisation of banknotes production with sophisticated security features.
Prospects for 2017-18
Global growth is gaining traction in 2017-18 with the recovery, driven primarily by a cyclical upturn in investment, manufacturing and trade. Tailwinds are also expected from the improving performance of emerging markets and developing economies (EMDEs). However, the path and pace of global growth will likely be shaped by structural factors, viz., the inwardlooking protectionist policies in advanced economies, low productivity growth and high income inequality impinging on the cyclical upturn.
Against the backdrop of these external developments, strengthening external demand will likely play a role in supporting the domestic economy. Favourable domestic conditions are mainly expected to enable a quicker pace of overall economic activity during the year. The expected normal monsoon and the resultant replenishment of reservoirs, policy initiatives of the government such as hike in MSPs and increasing crop insurance coverage are likely to help in boosting crop production and supporting rural demand. The implementation of HRA as per the recommendation of the 7th CPC for central government employees from July 2017 and the possibility of its implementation at the state level should strengthen urban consumption demand.
Headline inflation is forecasted in the range of 2.0-3.5 per cent in the first half of 2017-18 and 3.5-4.5 per cent in the second half. The continuing increase in currency in circulation on the back of remonetisation is likely to reduce the magnitude of the liquidity overhang during the course of the year. Notwithstanding the rapid remonetisation process, currency demand appears to have attained a new normal (currently around 87 per cent of the pre-demonetisation peak) in view of the sharp increase in electronic modes of payments since demonetisation.
In the fiscal sphere, while the gains to growth, efficiency and tax buoyancy over the medium term from the recent implementation of GST are unequivocally recognised, near-term uncertainties with regard to revenue mobilisation therefrom – which could impact fiscal consolidation at both centre and state levels – cannot be ruled out as this fundamental reform gains pan-India traction.
In the external sector, a slump in export growth and an increase in imports widened the trade deficit to US$ 40 billion in Q1 of 2017-18, the highest since Q2 of 2013-14. The evolution of terms of trade is likely to be largely shaped by the outlook for oil production in the US and compliance with the extended production cuts announced by the Organisation of the Petroleum Exporting Countries (OPEC). Even though the outlook among major trade partner economies entails a modest expansion, increasing recourse to protectionist measures in advanced economies could impose a challenging business environment for exports.
In the banking arena, the actions of the central government authorising the Reserve Bank to direct banking companies to resolve specific stressed assets by initiating insolvency resolution process are expected to significantly improve the resolution of stressed assets, particularly in consortium or multiple banking arrangements.