Here’s How The Economy And Banking Sector Fared Under Urjit Patel

As Patel enters the third year of his tenure, he is overseeing an enviable growth-inflation mix in the economy.

Urjit Patel completes two years as the governor of the Reserve Bank of India this week.

Over the past two years, Patel has dealt with the aftermath of demonetisation, overseen a turn in the monetary policy cycle and continued a clean-up of the banking sector initiated by his predecessor Raghuram Rajan.

While Patel has overseen an economy with a healthy growth-inflation mix, indicators across the banking sector remain worrying. To be sure, a number of domestic and external factors, many of them outside the purview of the RBI, impact economic indicators both negatively and positively.

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The Rate Cycle

Patel took over the economy at a time when growth was steady and inflation was set to meet an interim target of 5 percent set for the end of 2016-17. As such, his tenure started in the midst of an interest rate easing cycle.

In October 2016, Patel chaired the first meeting of India’s newly established Monetary Policy Committee. The committee voted unanimously to cut rates.

Soon after, the focus shifted away from just growth and inflation. In November, the government announced its decision to demonetise. With 86 percent of the economy’s currency scrapped, growth and inflation both took a hit. Just as the economy was starting to recover, the implementation of the Goods and Services Tax introduced another bout of volatility.

For a while, the MPC waited for growth and inflation to stabilise. In August 2017, it cut the repo rate to 6 percent - the lowest in about seven years.

The cycle turned in less than a year. With the 4 percent inflation target in sight, the MPC has hiked rates twice this year, taking the benchmark rate back to 6.5 percent.

The Growth-Inflation Mix

As Patel enters the third year of his tenure, he is overseeing an enviable growth-inflation mix in the Indian economy.

Growth is seen accelerating to 7.4 percent in 2018-19, with inflation seen remaining below the 5 percent mark. For an economy, which has become accustomed to either inflation overshooting or growth under performing, maintaining a sustainable mix will be a challenge.

With two rate hikes in the bag, some economists expect that a third may be in the offing closer to the fourth quarter of this fiscal year. The higher rates will help keep a lid on consumption, which is already outstripping investment in the economy. This, in turn, will keep actual growth close to potential growth and keep demand-driven inflation in check.

The higher rates will also help reinforce the credibility of the inflation targeting framework, which some economists believe has already helped in stemming inflation expectations, which can then feed into actual inflation.

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Turbulent Markets

If growth and inflation look relatively stable as Patel enters his third year in office, market conditions appear to be anything but.

Both the currency and the bond markets are turbulent.

In the bond markets, yields collapsed after the announcement of demonetisation. As a rush of money entered the banking system, the money was parked in government securities, driving down rates. The 10-year yield fell to a low of 6.18 percent on November 24, 2016.

It didn’t last. As withdrawal restrictions were lifted and remonetisation was completed, money flew back out of deposits.

Bond markets took a sharp turn when fears of fiscal slippage and high government borrowing sent yields soaring. The RBI, however, refused to intervene to control yields and reiterated that it would only intervene to provide systemically needed liquidity. After a few months of calm, yields are rising again. On Monday, the 10-year yield hit 8 percent for the first time in almost four years.

Currency markets have been turbulent too. The Indian currency is trading at record lows and fell below 70 to the U.S. dollar this year. Higher oil prices, a widening current account deficit have been factors that have weighed on the Indian currency. While the RBI has intervened to control volatility, markets perceive the RBI under Patel as being less-interventionist in the currency markets.

Bad Loans Remain Elevated

Banking sector indicators have remained worrying over the last two years.

The asset quality review initiated in 2015,and continued through Patel’s tenure, has led to a higher level of reported non performing assets.

The gross non-performing asset ratio of scheduled commercial banks could rise up to 12.2 percent by March 2019 from 11.6 percent in March 2018, the Reserve Bank of India said in its Financial Stability Report.

In May 2017, the government passed an ordinance, which gave the RBI additional powers to direct banks on using the insolvency and bankruptcy code (IBC), to resolve stressed loans. Following this, the regulator sent two lists, comprising of 40 stressed corporate accounts, to bankers for insolvency proceedings. Banks were also directed to make elevated provisions against these 40 accounts.

To fine tune the stress resolution mechanism, the RBI also scrapped all the existing restructuring tools like strategic debt restructuring (SDR), 5/25 long term refinancing, scheme for sustainable structuring of stressed assets (S4A) and brought up a fresh set of simplified guidelines in February 2018.

However, resolutions remain slow and the extent of recovery also remains unclear. This means that the RBI will need to push banks to strengthen their balance sheets by increasing provisions, which are still not seen as adequate.

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(This story was originally published on BloombergQuint.)