Reserve Bank of India between a rock and a hard place
It's been a difficult two weeks for believers in the rupee and India. For one thing, the decline in the rupee woke up all the rupee Cassandras out there, with talk of a currency crisis, speculative runs on the rupee and other dire warnings. Yahoo then splashed an article across its front page about how the price of onions, a staple in Indian food was fueling inflation. Then Raghuram Rajan, India's central bank governor raised the repo rate to 8%, facing a no-win situation of declining GDP (forecast to be at 5.1% this fiscal year) and cost-push inflation of 9.5% for August, based largely on higher food costs. What's a Chicago supply-side central banker to do? Well raise rates, of course, since Mr. Rajan is well known for advocating austerity and de-regulation, and that's what he did.
It seemed to bolster the rupee somewhat. The question is whether the fundamentals warrant optimism about the Indian economy in general and the rupee in particular.
Battening down against the inflationary fever in India
Mr. Rajan is not prone to splashy rhetoric. It seems that his supply-side approach has already born fruit, as is evident when one examines the latest balance sheet of the RBI. Parsing the different components of the money supply, one notices the imprint of Mr. Rajan's severe approach.
Money supply components
(as % of total money)
Currency with the public
Demand deposits with public
Net bank credit to government
Net bank credit to commercial sector
Net foreign exchange assets of banking sector
Time deposits with banks
Percentage variation year on year
Source: Reserve Bank of India
It should be heartening for rupee bulls that the net foreign exchange assets of the banking sector has increased by 2% (from 11.2% to 13.2% of the money supply), just in case there's a run on the rupee. While currency in circulation has declined, countering the inflation fever in the economy; countering this trend is an increase in demand deposits to 10% of the total money supply. It also seems that Mr. Rajan is being especially stingy in extending credit to either the government or the commercial sector.
Big banks not too stretched out.
It's a well-known fact that one of the first effects of a currency crisis is to batter the banking sector of the country. This can happen especially if the balance sheets of the leading banks are weak, and, in particular if liabilities are denominated in foreign currencies. The two biggest banks in India are the State Bank of India (OTC:SBKJY) and ICICI Bank (IBN). (Market caps respectively of $17.84 and $17.9 billion). The State Bank of India is 60% government owned, and thus, presumably would be too big to fail. The 2012 results show middling performance, with $24 million in non-performing assets. The bank also holds $116 million in "innovative perpetual debt instruments" both inside and outside India as well as $2.6 billion of borrowings at the Reserve Bank of India. The following, in a nutshell are several performance indicators between 2012-2013 for the bank.
Change in performance indicators
Growth in reserves
Change in net interest income
Growth in deposits
Change in capital adequacy ratio
State Bank of India
Source: State Bank of India
It is likely that, given Mr. Rajan's proclivities, any inadequacies in the SBI's capital structure will not lead to any intervention by the Reserve Bank - he'll probably leave the SBI to its own devices, and allow the markets to sort matters out, especially given ICICI's growth in market share, and that nationalization of weak banks is no longer considered a solution in India these days.