FSR indicates stable domestic financial system, highlights concerns

Vidrum / 23 Dec 2011

On Dec 22, 2011, the RBI released its Financial Stability Report (FSR), which is an assessment of the health of India’s financial sector.
On Dec 22, 2011, the RBI released its Financial Stability Report (FSR). The report is an assessment of the health of India’s financial sector. It also provides information about the key risks are arising from the macro and micro environments, the financial markets etc.

The FSR guided that the domestic financial system is stable, but there are concerns on the asset quality of banks, the volatile equity and currency markets and the uncertain global environment. The following are the key takeaways from the report:
  • It observed that the domestic financial system remained stable even in an uncertain global environment. Markets participants and stakeholders felt confident about the Indian financial sector. However, the report said that there are some issues that need to be looked into.
  • Domestic growth slowdown is one of the major issues that the economy is headed towards. The Finance Ministry recently revised the GDP growth rate for FY12 to 7.5%. Also, the IIP for the month October 2011 grew by negative 5% on a YoY basis. One of the major reasons behind the slowing growth is the RBI's hawkish monetary stance, which has seen the interest rakes being hiked 13 times since Mar 2010 in a bid to curb inflation. Now, inflation has shown signs of cooling, which is evident from the fact that food inflation came in at 1.81% for the week ended Dec 10, 2011 against 4.35% in the previous week. However, fuel inflation continues to remain high on the back of high crude prices and the depreciation of the rupee. In the next monetary policy, we believe that the RBI may take some steps to drive growth back on track, as inflation is slowly coming under control.
  • The fiscal situation in the economy is under pressure. This is evident from the fact that for the 7-month period between Apr-Oct 2011, the fiscal deficit stood at 74.4% of the budgeted estimate for FY12. With this, the govt. projection of the 4.6% fiscal deficit target for FY12 will most probably not be achieved.
  • The Indian equity and currency markets both remained volatile over the past couple of quarters. On a YTD basis, the Sensex is down by 23% to levels of 15800, and the rupee has depreciated by approximately 19% and is currently trading at 52.70 against the USD. The rupee's depreciation will affect the companies and would increase the cost of borrowing (ECB and FCCB funds), which will widen our trade deficit.
  • Banks are facing the strongest headwinds in terms of maintenance of Capital Adequacy Ratio (CAR) and arise in Non-Performing Assets (NPAs). The public sector banks are in need of funds for their further growth, but due to an imbalance in the govt’s revenues, they are not able to get the funds in a timely manner. The Net NPAs of many public sector banks have seen a steep rise on the back of exposure to sectors like real estate, textiles, aviation and others. In Q2 FY12, Bank of India and Union Bank have witnessed a sharp deterioration in their Net NPAs, which increased by 84 bps to 1.98% and 86 bps to 2.04% respectively.
  • The FSR also conducted a risk assessment in the financial services sector, and half of the respondents were confident or very confident about the system. The respondents also gave an outcome that banking system looks distressed, and the risk of asset quality deterioration is the most significant one. Also, the mutual funds and insurance businesses seems to be weak, on the back of a disturbed banking system.
The next FSR is scheduled to be published in Jun 2012. Overall, the FSR report by the RBI guides us that banking system is stable but there are other concerns affecting economy. Growth remains a key focus on the govt’s radar. However, fuel and WPI inflation is still above the comfort zone. We, at DSIJ, believe that the coming quarters will be more challenging for the economy, and investors should wait and watch for how the situation evolves.

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