Mumbai: The Reserve Bank on Monday ruled out any major impact on domestic markets by the US Fed's tapering its monthly bond buying programme from later this week, saying that India's external sector has improved with reduction in CAD and a pick up in exports.
RBI Governor Raghuram Rajan warned however against the rising tide of bad loans saying risks to the banking system have increased over the past six months. But, he added that there are no systemic risks at the moment.
The economy is taper-ready, he said in the half- yearly financial stability report released on Monday.
"The effect of the tapering on the economy is expected to be limited and short- lived," as the external sector risks to the economy have considerably come down over the past few months," he added.
Pegging the Current Account Deficit at below 3 per cent of GDP, the report said "the country's external position appears to be manageable and reserves seem adequate," which stood at over USD 295 billion in the third week of December.
However, it added: "The banking stability indicator shows that risks to the banking sector have increased since June 2013."
The tapering, from January, of the USD 85-billion monthly bond buying programme by US Fed to prop the American economy, has given India time to replenish forex reserves and rein in high CAD, which was at 3.05 per cent in first half of this fiscal (2013-14) as against 4.8 per cent last fiscal.
The US Fed announced this month that it would cut back on bond buying by USD 10 billion to USD 75 billion a month following improvement in the world's biggest economy.
Warning on the high inflation as a hurdle for easy money policy, Rajan in his foreword said: "The outlook for the economy has improved, with export growth regaining momentum, but growth is still weak. The challenges of containing inflationary pressures limit what the monetary policy can do."
Inflation based on wholesale price index, hit 14-month high of 7.52 per cent in November. Retail inflation, based on consumer price index, rose to 9-month high of 11.24 per cent.
"Some moderation is expected in food inflation going forward, (but) persistence of retail inflation remains a concern," the report said, adding that "persistently high inflation" and the consequent pressure on interest rates poses a downside risk to growth.
On the rising NPAs, the report warned that "strain on asset quality continues to be a major concern".
In a base case scenario, with present conditions continuing, gross NPAs will rise to 4.6 per cent by September 2014 from 4.2 per cent in September 2013. As of Q2 this fiscal, GNPAs stood at Rs 2.29 trillion (Rs 2.29 lakh crore) from Rs 1.67 trillion a year earlier, it added.
The amount of recast loans also touched all-time high of Rs 4 trillion or 10.2 per cent of overall advances as of Q2, or July-September quarter of 2013-14 fiscal. However, RBI expects some positives in the next fiscal and has estimated that gross NPAs would improve to 4.4 per cent by March 2015.
In case the economic condition deteriorates, it could be 7 per cent by March 2015, the RBI warned. State-owned banks will be the worst-affected, the report said, pegging GNPAs for PSBs at 4.9 per cent by March 2015, while for new private sector banks it will be 2.7 per cent.
The report reiterates that RBI will discontinue the system of relaxed restructuring of advances from 2015 onwards and warned that state-run banks will be affected the most as the provisions will shoot up.
"The regulatory concerns regarding restructuring arises from the possibility of the relaxations not being used judiciously by banks commensurate with the viability of projects. These relaxations for asset classification/ provisioning will be phased out by April 2015," it said.
High CAD, along with tapering fears, was one of the reasons for the rupee touching a lifetime low of 68.85 against the dollar on August 28 and forcing RBI to unleash a slew of unconventional measures to prop the battered currency.
The rupee has improved since then, but is still 14 per cent lower year-to-date. Authorities acted on multiple fronts, curbing gold imports, opening currency swap windows to get fresh dollars, and increasing money market rates to reduce speculation.
All these resulted in CAD improving and thus bringing investors back to the market. The biggest leveller had been a drastic fall in gold imports and USD 34 billion that RBI grossed up by way of the two swap windows.
Stressing upon the need for long-term solutions to the external sector problems for the country, the RBI report said the answer lies in increasing the productivity and the export competitiveness.
The report saw a modest improvement in growth in the second half (October-March) of this fiscal given the good monsoons which boosted the prospects of summer crops, apart from rising exports.
"To maintain the momentum gained by the respite, it is imperative that long-delayed legislative reforms are pushed through, stalled infrastructure project clearances continue and fiscal consolidation remains on track," Rajan said.
The report also pointed to the high fiscal deficit and fall in domestic savings as major concerns. It said the revival of the fiscal responsibility legislation and a reduction in government borrowings can complement financial market development and improve confidence in the economy by way of dis-inflationary trends.
The report warned, however, of a new set of risks staring at the economy from the forthcoming polls, which the Governor termed as a "potential source of uncertainty" saying any post-election instability will imperil the already beleaguered economy further.
"A potential additional source of uncertainty is the coming general elections. A stable new government would be positive for the economy," Rajan said in the foreword.
Warning that any political instability will lead to further erosion of investor confidence, he said: "With confidence in the financial system still fragile, six years into the crisis, policy certainty is something that investors look for in the current environment."
The warning comes amid some political observers expecting a hung Parliament after the Lok Sabha elections in a few months.