As with episodes of financial sector stress elsewhere, financial institutions are increasing their exposure to low-risk government bonds. While banking system exposure is generally well documented, it is less so for non-banking financial companies.
We know mutual funds have been steadily reducing their debt exposure to NBFCs and simultaneously raising exposure for G-Secs. Once again, this de-risking is likely to continue as financial sector stresses are unlikely to be resolved soon.
While banks’ non-performing assets (NPAs) have been mildly reduced, the process has been slower than anticipated following the passage of a new bankruptcy code in India.
More than a third of debt resolution cases now exceed the stipulated time limit of 270 days. In addition to the banking system, the asset quality of NBFCs and housing finance companies (HFCs), which have significant exposure to the troubled real estate sector, should deteriorate after the start of stringent NPA recognition norms.
The exposure of NBFCs and HFCs to the economy is not trivial, amounting to around 13 per cent of GDP.
After a formidable deficit in 2018, India’s BoP position has steadily improved. This is not confined to just portfolio flows but is across the current account, FDI flows and external borrowings.
For the four quarters ending June 2019, the current account deficit dropped to 2.1 per cent of GDP from a peak of 2.4 per cent in the final quarter of 2018.
Gauging by contemporaneous trends in the customs-cleared trade balance, further compression in the current account deficit is likely. This compression correlates well with the widening output gap.
In ANZ Research’s view the strengthening BoP position allows the RBI to inject liquidity into the economy via its FX operations. Indeed, the relationship between FX intervention and banking system liquidity has tightened of late. RBI money growth is increasingly driven by a rising contribution from net foreign assets (NFA). It has even allowed the RBI to step down on its open market purchases to provide liquidity.
In the last few years, two formidable changes in the sources of government funding have occurred.
The first is growing demand for duration from the non-banking system, including insurance companies and mutual funds. The demand from these sources has offset the weaker demand from banks which peaked in the first quarter of 2018.
Consistent with rapid secular growth in the insurance sector, this dynamic probably has further to run. Moreover, as cited earlier, financial sector stresses are leading financial institutions to increase exposure to G-Secs.
The second change has been a growing recourse to small savings. These are quintessentially retail savings tapped directly by the government. From a negligible amount in 2013, small savings financed roughly 18 per cent of the central government’s deficit in fiscal 2018 and 2019.