The contraction in economic activity will likely prolong as states reimposed stricter lockdowns, the annual report of the Reserve Bank of India (RBI), released on Tuesday morning, said. It is important to withdraw the stimulus measures once the cure to Covid-19 is found, the report adds.
High frequency indicators so far pointed to a “retrenchment in activity that is unprecedented in history,” the annual report said, adding, “the upticks that became visible in May and June after the lockdown was eased in several parts of the country, appear to have lost strength in July and August, mainly due to reimposition or stricter imposition of lockdowns, suggesting that contraction in economic activity will likely prolong into the second quarter.”
The central bank noted that the shock to consumption is severe, and it will take quite some time to mend and regain the pre- pandemic momentum.
Public finances have stretched to fight the pandemic, and supporting demand led activities would be severely diminished. “In the case of state finances, space is likely to be squeezed so much that cuts in growth-giving capital expenditure seem quite probable.” The future path of fiscal policy is likely to be heavily conditioned by the large overhang of debt and contingent liabilities incurred during the pandemic.
“A credible consolidation plan, specifying actionables for reduction of debt and deficit levels, will earn confidence and acceptability, rather than just extending the path of touchdown,” the report said.
The RBI suggested the government must use big data and technology to track and identify tax defaulters, increase the tax payer base by tracking their income and wealth parameters, and by addressing the challenges confronting the GST regime through rationalization, and simplification. Employment generation should be the focus and fiscal incentives can be given to productive labour-intensive companies.
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Besides, the state and central governments should explore monetisation of assets in steel, coal, power, land, railways and privatisation of major ports to revive and crowd in private investment.
The role of banks and non-banks have waned as primary financial intermediaries, in favour of capital and bond markets.
“In all this, the usual risks are relegated to the background where they may be sinisterly mutating – fiscal dominance; inflation; leverage; market failure. Meanwhile, the crisis presents opportunities and the shape of the future will depend on how well they are exploited,” the report noted.
However, the Indian banking system has to get rid of risk aversion that is impeding the flow of credit to the productive sectors of the economy and undermining their role as the principal financial intermediaries.
“The deterioration in the macroeconomic and financial environment is impinging on asset quality, capital adequacy and profitability of banks. Regulatory dispensations that the pandemic has necessitated in terms of the moratorium on loan instalments, deferment of interest payments and restructuring may also have implications for the financial health of banks, unless they are closely monitored and judiciously used.”
Although gross and net non-performing asset ratios had come down in March 2020 along with receding slippage ratios, the economic fallout of the pandemic is likely to test this resilience, especially since the regulatory accommodations announced in the wake of the outbreak have masked the consequent build-up of stress.
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The stress test reported in the June edition of Financial Stability Report showed that non-performing assets could surge 1.5 times above their March 2020 levels under the baseline scenario and by 1.7 times in a very severely stressed scenario. The system level capital adequacy ratio could drop to 13.3 per cent in March 2021 from its March 2020 level under the baseline scenario and to 11.8 per cent under the very severe stress scenario.
Therefore, both public and private sector banks need to be recapitalised, as the capital requirements calculated based on historical loss events, “may no longer suffice to absorb post-pandemic losses.”
Globally, central banks are funding the stimulus through their “unparalleled expansion of central bank balance sheets, unbridled by conscience-keeping inflation.” Keeping interest rate unusually low has meant that debt among both public and private have swelled as there are no servicing constraints. Therefore, the role of resource allocation, traditionally performed by the markets, has fallen on the central bank and the government.
“This can inevitably bring in political consequences unless these authorities fashion timely and credible exits after the virus has been overcome and the vaccine found.”
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