'Hot' foreign capital not the answer; banking sector requires vigilance, says Urjit Patel

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The government’s recent move to include Indian bonds in global indexes has opened doors to risky foreign capital inflows, former Reserve Bank of India (RBI) governor Urjit Patel has said.

“Last week, our breathless pursuit for being part of global bond indices gathered pace. Over the past year, we have incessantly relaxed prudential norms related to external flows management, opening up yet more the possibilities of surges and sudden stops of “hot” foreign capital with well-known attendant consequences,” Patel wrote in the Financial Express newspaper on April 6.

"It is an expedient policy in the hope that it will lower borrowing costs for the central government; this may only help in the short run, and in the current environment even that is not apparent," the former RBI governor said. "Going down this policy route is puzzling at a fundamental level."

He called for policymakers to be vigilant about the banking sector, which in the pre-coronavirus time was already stressed by high non-performing assets (NPAs).

"India’s NPA ratio is over 9 percent, among the highest for important economies, and it was projected to rise anyway. Questions about the sector in India persist despite comfortable capital adequacy ratios for most banks (and certainly the large ones)," Patel said.

Late last year, ten banks disclosed their NPAs for FY19 were Rs 26,500 crore higher than previously reported. This, along with "widely reported delays in resolutions" and "ad-hoc dilutions" would increase the sector's risk premium, he said.

“At some point, international investors will begin to sharply distinguish between countries along the principal measure of how successfully the health challenge is being met, which will determine how quickly and durably individual economies will get back on their feet,” Patel wrote. “This could induce another financial wave that we need to prepare for by maintaining relative macroeconomic stability.”

The former RBI chief hailed the welfare package provided by the government and central bank to support the impoverished section and bailout small enterprises, saying that it "has combined compassion and prudence." Any further monetary stimulus should also account for likely multiple impacts over an uncertain timeline that could last a year, he added.

Patel called for the government to expend more resources on testing now, as it could help the country plot an exit plan from the lockdown or reduce the need for multiple localised lockdowns later.