Funding current account deficit a challenge: RBI

“Financing of current account deficit is going to be a challenge as advanced countries begin exiting from their accommodative monetary policy stance," RBI said in its report, released on Tuesday.

If oil and commodity prices remain elevated, the current account deficit will remain significant, although higher growth in software exports and remittances may provide some cushion.  The RBI said it is committed to use a prudential mix of policy instruments to contain any adverse impact of easy monetary policy by the advanced economies. The GDP growth has downside risks on account of some domestic and international factors.
“The slackening of global recovery, high oil and commodity prices, deceleration in domestic industrial growth, uncertainty about continuation of strong growth in agricultural sector and impact of monetary policy actions pose downside risks to India’s GDP growth during 2011-12,” RBI said.

Hurt bank profits
Inflation is likely to face upward pressure from higher subsidy expenditure of the government, rise in wages and raw material prices, RBI said in the report.
“Management of government expenditure, especially subsidies bill, will pose challenges to the process of fiscal consolidation, which could be further accentuated by a tempered growth adversely impacting revenue collection,” it added.

High interest rates has increased the attractiveness of overseas borrowing in terms of interest rate differential and availability of credit, it said. The high and growing net external liability position of residents exposes the country to the risk of a sharp fall in the currency, it noted. The central bank also said increased reliance on market borrowing by Indian banks could adversely affect their liquidity position.

RBI further cautioned that rising interest rate and high cost of funds could hurt the profitability of the banking sector. “Going ahead, with hardening interest rates and imminent increase in cost of funds, credit growth is expected to slow down, which could adversely affect profitability,” RBI said.

The hike in savings account interest rate, amortisations of pension liabilities and potentially enhanced provisioning requirements for NPAs may also impact profitability, it said.

The report noted that banks’ profitability improved, buoyed by increased net interest income though non-interest income remained stagnant.

An increase in net interest income (NII) facilitated growth of around 20 per cent in aggregate net profit of the banking system, even with an almost stagnant non-interest income and increase in risk provisions, it said. Interest income increased by 18.6 per cent over 7.5 per cent last year and interest expense increased by 10.1 per cent as against 4.0 per cent last year, it said.

The study indicates that some banks may face extreme liquidity constraints, under severe stress scenario. Overall, the results of the macro-stress tests using different scenarios, suggested that the banking sector would be able to withstand macroeconomic shocks though the prevailing inflation and interest rate situation is expected to have an adverse effect on the asset quality of banks.