RBI Releases Financial Stability Report

At a time when there is growing uncertainty about the health of many Western banks, the latest version of the Financial Stability Report (FSR) just released by Reserve Bank of India (RBI) is reassuring. Indian banks remain robust though capital adequacy ratios have fallen and Non-Performing Assets (NPAs) have increased.
Capital Adequacy of Banks
Stress tests show banks are reasonably resilient though the capital adequacy of some banks could be adversely affected under severe credit risk stress scenarios. At a more disaggregated level, the picture is less encouraging. In particular, the consequences of, largely, public sector banks' headlong rush into lending for infrastructure projects, often at the behest of the government and the RBI, are now evident.
The report warns the 'growth rate of credit to the power sector has been much higher than the aggregate banking sector's credit growth and could unravel in case of a sharp economic downturn'. The same could also be said about bank lending to other infrastructure sectors such as real estate and airlines.
Low-Interest Rate Regime
A slowdown in domestic growth could raise the risks for the banking system as loans made in the low-interest rate regime of the previous two years turn sticky. More so since, as the report points out, all components of domestic demand, private, government, consumption and investment, have decelerated. On the external front, Indian banks with their limited exposure to overseas markets are relatively safe.
Nonetheless, contagion from the European sovereign bond markets to international banks could trigger further deleveraging and raise the cost of foreign currency loans for Indian banks and corporates. However, to the extent regulatory arrangements worldwide have been strengthened with national regulators recognizing the importance of a coordinated approach, the system is, hopefully, less vulnerable than before.
Real Test
The real test is whether the financial market infrastructure, in particular the payment and settlement systems, will continue to function without major disruption, when the next crisis strikes. As long as the lessons of the 2008 crisis have been learnt, there is reason to second the FSR's vote of confidence.

Vietnam's Choices for Post-Financial Crisis, Monetary Policies

The Vietnamese economic development in 2010 depends largely on the targets we have set on and the selection of macroeconomic policies to attain these targets. These targets on their part will require the choice of appropriate macroeconomic policies. This is why we should be careful in choosing macroeconomic policies and socioeconomic development targets in the short, medium and long term, based on scientific and realistic reasoning.

Strategy for Socioeconomic Development
The year of 2010 is the last one in the implementation of the 2001-2010 Strategy for socioeconomic development period so this is the last opportunity to achieve the targets of the strategy. With the most important target to double the Gross Domestic Product (GDP) after 10 years, it is necessary that the economic growth rate in 2010 must attain at least 6.5percent as set by the National Assembly's Resolution. On this bumpy road, the Vietnam's economy "vehicle" still relies on the traditional driving forces that are:

First, economic growth still relies mainly on the increase of investment with the total social investment capital ratio growing continuously from one third of GDP in the last part of the 20th century to nearly 40 percent in the last few years, ensuing the overall investment effectiveness has decreased drastically as demonstrated by the high ICOR index.

Second, the slow restructuring of the economy created no change in quality of growth, even though the speed of economic growth might attain the strategic target and more critically, no premises can be created to get a breakthrough for higher growth rate.

Third, the growth model is based on exports while the change of export commodities and markets structure is limited. Within the structure of export commodities, the ratio of raw materials and resources still occupy a large share while the light industrial group of products is mainly composed of cheap labor-intensive processing products with low value added.

Fourth, the stability of macro economy is not solid yet. The inflation rate (as reflected by CPI [Consumer Price Index]) in the period of 2001-2010 is lower that the preceding one. However, if inflation in the period of 1991-2000 followed a downward trend, it started to go up since 2001.

Affecting Economic Growth
Control of inflation has become a focal concern in the stabilization of the Vietnam's macro economy during the last few years, but recently, the efforts to maintain the main equilibriums of the economy have created many problems affecting directly the stability of the macro economy and limit the space for the management of policies. The most striking example is the deficit in the trade balance. Although export trade has made outstanding gains in turnover, because of the limitations in structure, in export development model and in imports control, excess imports have persisted for a long period of time and affected negatively on the economic growth and the socioeconomic stability.

The target to control imports to reduce the trade deficit to under 10 percent of the GDP and under 20 percent of total exports turnover is very necessary to stabilize the macro economy and at the same time to create a premise and motive force to restructure the economy and speed up the time to regain the trade balance equilibrium.

Trade deficit is the decisive factor causing the heavy deficit in the current balance of payments in recent years and dragging along deficit in comprehensive balance of payments. In addition to trade deficit, State budgetary deficit lingering for many consecutive years has also increased the risks for the economy, including growth risks and destabilization of the macro economy.

Fiscal Policy Options
The short-term focus of the fiscal policy is to ensure that the level earmarked to the state budget at one fourth of the GDP no less but also no more so as not to increase the burden to mobilize for the state budget of the economy. However, all discriminations about economic sectors should be reduced to the lowest level albeit to abolish completely both in obligations to contribute to the state budget as well as to benefit from the state budget spending or disbursement of such nature.

The second priority is to reduce the budgetary deficit in the roadmap to restore the state budgetary balance in the long-term.

Choice of Monetary Policy
If the fiscal policy should be "neutral" in short term basis and active in promoting the restructuring of the economy in the medium and long term range, the monetary policy will become the policy tool to promote economic growth and ensure macro stability. The flexible and marketable character of the monetary policy should be promoted to realize at the same time these two core targets.

On one hand, increasing aggregate credits has been and will be the key factor to promote economic growth while other financial channels for businesses are still scarce. Reality has shown that the economic growth rate of Vietnam has an organic link with opening up credits. On the other, the degree of stability of the macro economy, particularly inflation in Vietnam also has a dialectic relationship with the growth rate of credits though it has a certain latent period. Interest rates should be implemented flexibly and following market mechanisms.

Assessment
To achieve the important macro economic targets, particularly the control of excess imports, to attract foreign investments, to ensure the equilibrium of the balance of trade, current accounts and payments, to balance investment saving and consumer accumulative spending and to manage foreign debts, the foreign exchange policy will play a very important role.

It is foreseen that, under the pressure of the economic disequilibrium between domestic and foreign scenes, in 2010, the devaluation of the Vietnamese Dong is inevitable but the scope and timing should be synchronized with the foreign exchange control and trade policy in order not to create a shock to the macro economic stability while refraining from too much expectation in solving immediately all the macro disequilibrium that have been accumulated through the recent years, especially with only a separate tool such as the exchange rate adjustment.