RBI’s annual report paints a cloudy picture of what’s next for the Indian economy

• India’s central bank, the Reserve Bank of India (RBI), released its annual report for 2017-18 on Thursday.
• Both negative and positive, the report says that Indian economy will have to precariously balance itself to brace for the coming year.
  
• The report also highlights how, despite the Indian government's objectives, the goals laid by the Prime Minister are far from their intended targets.

India’s central banking institution, the Reserve Bank of India (RBI), just released its annual report for the year 2017-2018, bringing some key issues of the Indian economy into the limelight.

On the one hand, the report states that the Indian economy is set to unlock its growth potential through the intensification of structural reforms but on the other, the threat of inflation and non-performing assets (NPAs) still looms overhead.

And, though the RBI predicts strong growth for India’s secondary and primary sectors, it also speculates that the country will face challenges in the banking industry and from volatility in international markets.

The good with the bad, these are some of the key observations put forward by the RBI in their report.

The curious case of India’s current account deficit

Domestic consumption hasn’t lost its step with India maintaining its stature as the preferred destination for foreign direct investments (FDIs). As per the report, it’s the manufacturing sector supported by its counterparts that have made this possible.

Domestic consumption, in turn, is a result of an increase in capital expenditure as well the push towards exports. Foreign capital is largely flowing into communication and computer services, retail and wholesale trade, as well as financial services.

Mauritius and Singapore take the lead in FDIs with combined equity investments of around 61%.

Turmoil in international waters

The sanctions placed by the United States on Iran won’t only impact India’s imports but the overall international supply of oil. That in turn, won’t play out well for India’s trade deficit primarily because of India’s increasing energy demands.

A potential increase in India’s current account deficit opens the doors for inflation risks to throw shade on the Indian economy. The RBI has stressed on the importance of heading off these pressures before they generalise into adverse trends.

The counting of demonetised notes is complete

Last year’s report told us that 99% of the banned currency notes had found their way back to the banks, and this year that’s up by 0.3%, which isn’t really all that significant. While the RBI’s efforts to process and verify specified bank notes should be commended, one has to ask whether the effort was all for nought.

Prime Minister Narendra Modi’s initiative to catch black money only seems to have led to an extreme cash shortage that steamrolled into sluggish economic growth, a loss for businesses and over a million people losing their jobs. The informal economy, in particular, is still suffering from its after-effects.

To fake or not to fake

The new currency notes despite the numerous so-called ‘úpgrades’ are still vulnerable to being counterfeit, just like the old currency notes. And, it’s not just the bigger denominations of ₹500 and ₹2,000, but also the ₹50 note.

The only difference is that the overall number of fake notes that are in circulation has taken a dip.

Return of the cash economy

While demonetisation and the resulting short supply of cash did lead to an increase in digital cash payments, the return of liquidity in the economy shows people coming back to the comfort of cash.

In fact, if RBI’s estimates are to be taken at face value, the liquid currency kept at home has increased to 2.8% of the total gross national disposable income (GNDI), which is the highest it’s been in seven years. Even savings are at a seven-year high of 11.1%.

That being said, it’s not that the Indian population has reverted from digital payments altogether. Non-cash transactions are still increasing, just a rate slower than last year’s and that is indicative of the fact that despite all the new online payment platforms, cash is still the preferred method of exchange.

Banking drama

With the number of bank frauds that have come into the limelight this past year, it’s hardly surprising that the RBI speculates that bad loans is going to increase even further in the coming year.

According to the report, the ‘prevailing economic situation’ is a combination of mark-to-market treasury losses and the increase of provisioning against non-performing assets (NPAs). Which basically means that the banks didn’t make much of a profit on their investments in the stock market and have had to set aside an increasing amount of money to hedge against bad loans.

That being said, the overall flow of financial resources from the banking sector to the commercial sector has shown an increase, with the former accounting for 43% of all fund flows to the latter. That means that there's scope for credit absorption. But that will only be efficiently done if the problem of NPAs is appropriately addressed and banks are sufficiently re-capitalised after facing large losses.