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Demonetization, GST has potential to transform economy: RBI

RBI on Thursday said GST and demonetization have the potential to transform the economy, “notwithstanding some inconvenience to public and momentary adverse impact on growth”, even as it flagged elevated risks due to continuous deterioration in banks’ asset quality.

It also observed that while the financial performance of the corporate sector has improved in 2016-17, the risk of lower turnover remains. It also said large borrowers registered significant deterioration in their asset quality. “The measures such as transition to the nationwide GST and the withdrawal of legal tender status of specified bank notes (old Rs 500/1000) could potentially transform the domestic economy, notwithstanding some inconvenience to public and the momentary adverse impact on growth,” RBI said. These observations were made in the Report on Trend and Progress of Banking in India 2015-16 (RTP) and the 14th issue of the Financial Stability Report (FSR).

In his foreword to FSR, RBI Governor Urjit Patel said the withdrawal of Rs 500/1000 notes “will impart far reaching changes going forward”. “It is expected to significantly transform the domestic economy in due course in terms of greater intermediation, efficiency gains, accountability and transparency through increasing adoption of digital modes of payments, notwithstanding the short-term disruptions in certain segments of the economy and public hardship,” he said. The Governor also cautioned that there is “little room” for complacency and it is important to guard against sporadic volatility in financial markets.

RBI further said that the banking stability indicator shows that the risks to the banking sector remained elevated due to continuous deterioration in asset quality, low profitability and liquidity. The business growth of banks remained subdued with public sector banks (PSBs) continuing to lag their private sector peers. System level profit after tax (PAT) contracted on y-o-y basis in the first half of 2016-17.

The asset quality of banks deteriorated further between March and September 2016. PSBs continued to record the lowest capital to risk-weighted assets ratio (CRAR) among the bank groups with negative returns on their assets.

“The GNPA (gross non-performing advances) ratio of SCBs increased to 9.1 per cent in September 2016 from 7.8 per cent in March 2016, pushing the overall stressed advances ratio to 12.3 per cent from 11.5 per cent. “The large borrowers registered significant deterioration in their asset quality,” said the central bank. “Overall, India’s financial system remains stable although banks, particularly the public sector banks, continue to face significant levels of stress,” the FSR report said.

It further said the macro stress test shows that GNPA ratio of banks “may increase further” under assumed baseline macro scenarios. The PSBs may record the highest GNPA ratio and lowest capital to risk-weighted asset ratio (CRAR) among bank-groups although the CRAR at the system as well as bank-group levels is expected to remain above the regulatory required minimum. On macro-financial risks, it said that in the external sector, the narrowing of the CAD partly reflects the external spillovers in the form of sluggish trade growth.

“The decline in the flow of remittances is also a concern. Going ahead, capital flow, more than trade, is likely to influence the exchange rate,” it said. It also said that with the implementation of global regulatory reforms, most of the major international banks have become more resilient in terms of capital and liquidity. However, risks of divergence from the demanding global standards amidst discriminatory treatment of foreign financial institutions seem to have increased.

Globally, some risks inherent in banks may be getting transferred to other segments of the financial markets due to increased regulatory scrutiny and elevated capital requirements for banks.

As per the RTP 2015-16, the performance of banking sector remained subdued during 2015-16 amidst rising proportion of banks’ delinquent loans, consequent increase in provisioning and continued slowdown in credit growth. However, banks’ retail portfolios registered double-digit growth during the year.

During 2015-16, banks’ interest earnings and non-interest incomes were adversely affected, which led to a more than 60 per cent drop in net profits for the banking sector.

Banks’ return on assets (RoA) and return on equity (RoE) showed a substantial decline as compared to the previous year even as the PSBs reported negative RoA, it said.