RBI’s Financial Stability Report & Change in base year for IIP and WPI

RBI’s FSR: Banks NPA may further rise

Reserve Bank of India (RBI) released its 15 th financial stability report (FSR) on July 2. According to the FSR, the domestic and global economic outlook remains positive. But, bad debt of Indian banks may rise in FY18.

What is RBI’s FSR?

The global financial crisis of 2008 has prompted global regulators to mandate banks to undertake stress tests to see if their risk appetite matches their risk taking capacity. Financial regulators and central banks in over 60 countries publish FSR bi-annually about the health of their banking, financial and systems. In line with this global trend, RBI has also been publishing FSR bi-annually since 2009.

Broadly, what does the FSR intend to do?

FSR throws light on the risk to the entire financial system. FSR assess the resilience of the financial sector through stress tests. FSR also focuses on emerging issues of systemic importance to the economy. It also outlines regulatory and consumer protection measures taken in the recent past by all financial regulators. Thus, broadly FSR aims to enhance transparency in the system.

Why is the FSR widely tracked by experts and markets?

The FSR reviews the nature, magnitude, and implications of risks on the macro environment. This has a direct or indirect bearing on various asset classes. RBI’s commentary on macro outlook is important.

So, what does FSR say on the global macro environment?

While the FSR is positive on the global growth scenario it is worried about elevated geopolitical risks and weakening of international institutional mechanisms to deal with them. RBI is also taking a wait-and- watch approach to assess the rhetoric on protectionism and populism globally.

What is the outlook for the domestic economy?

FSR is positive on domestic economic growth prospects on the back of political expected to be at 7.3 per cent in 2017-18. Going forward, FSR says, reforms in foreign direct investment, implementation of goods and services tax (GST), and revival in external demand are likely to contribute to a better growth outlook.

However, FSR says, for sustainability of higher growth rates, revival in investment demand of private sector is essential.

What does FSR say on the fiscal deficit?

FSR has acknowledged that government’s commitment to fiscal discipline had a positive impact on macroeconomic outlook. But, RBI is worried about fiscal positions of some States and the stretched debt capacities of some state owned enterprises.

What is the outlook for inflation?

According to FSR, CPI inflation is expected to be in the range of 2.0–3.5 per cent in the first half of the fiscal year and 3.5–4.5 per cent in the second half.

What is the outlook on banking sector?

FSR has acknowledged that more and more borrowers are relying on other-than-banking sources like mutual funds and bond market for their borrowing needs. While banks capital position is sound, stress test has indicated that under the baseline scenario, gross non-performing assets (GNPAs) of banks may rise from 9.6 per cent in March 2017 to 10.2 per cent by March 2018. This number can worsen if the macroeconomic conditions deteriorate.

So, what are other important takeaway from the FSR?

The report has highlighted that Indian banks will need higher provisioning from April 2018 due to transition to new Indian Accounting Standard (Ind AS). This will lower bank’s profitability.

Re-basing IIP and WPI

Recently the base year for calculating Index of Industrial Production (IIP) and Wholesale Price Index (WPI) was changed from 2004-05 to 2011-12. IIP gives us an idea about growth or fall in industrial activity in the country. WPI gives us an idea about growth or fall in wholesale inflation in the country. Both are important for policy makers and markets.

Why change base year for WPI and IIP?

A change is base year for IIP and WPI was needed to capture structural changes in the economy and improve the quality, coverage, and representativeness of the data. With the change in the base year, IIP and WPI are now aligned with base years for Consumer Price Index (CPI) and Gross Domestic Product (GDP).

What are IIP and WPI?

IIP denotes the growth of the various sectors of the economy including mining, electricity and manufacturing, while WPI is the price representative of a basket of wholesale goods divided into primary articles, fuel & power, and manufactured products.

Who compiles WPI and IIP?

Office of the Economic Adviser, Department of Industrial Policy & Promotion is entrusted with the task of releasing WPI. Central Statistics Office (CSO), Ministry of Statistics and Programme Implementation releases IIP. These data are released monthly. The series with a new base year has been revised after eight years.

What is a base year?

The base year is nothing but the starting point from when an index is constructed. At that starting point, the index is assigned a value of 100. Now if the index (it could be a stock market, WPI, CPI, IIP or GDP) goes up to 102, the index is said to have gone up by 2%. Remember, the index can have different components. These components can be given different weights.

Why change the base year?

Often, economist and analysts complain that economic data is not in sync with reality on the ground. Base years are thus periodically revised to keep data relevant. Even components and weights assigned to those components are changed to reflect the true picture.

So, what are the changes in components for calculating WPI?

Apart from a change in base year, in the new series of the WPI, the number of items covered are increased from 676 to 697. In all, 199 new items have been added and 146 old items have been dropped. Weight for primary articles has been increased while weights for fuel and power basket have been reduced.

What are the changes in components for calculating IIP?

IIP in the revised series will continue to represent mining, manufacturing and electricity sectors, but weights for the manufacturing sector and mining sector has been increased. Weights for electricity have been pruned. Total item groups covered under the new series has been increased to 407 from 399 earlier.

So, how does the data look like for new IIP series?

The index of industrial production expanded slower by 1.7 per cent in May, as against the expansion of 2.8 per cent in April. Interestingly, the IIP data on new series shows that in none of the months in FY17 did the IIP contract. If old series is considered, IIP declined in six months — April, July, August, October, December, and February in FY17. Clearly, the industrial production was not as bad as was reflected by the old series.

How does the data look like for new WPI series?

As per the new series, WPI inflation was at 2.17% in May 2017 as compared to 3.85% in April 2017 and (-) 0.9 percent in May 2016. Interestingly, as per new series, WPI inflation stood at 1.7% in FY17 as compared to 3.7% under the old series. Clearly, WPI inflation was lower in the economy in FY17 than what was reflected by the old series.

What does this mean for over GDP data?

The new series will improve the accuracy of the data. It will also make them comparable to GDP. WPI is used as a deflator for deriving real GDP values from nominal data. Various components of the IIP are used to derive GDP. Since WPI is lower and IIP higher as per the new series, there are chances that GDP can be revised upwards.

ends

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