Management Discussion and Analysis

The Global Economy

The global economy continued to remain in melancholies during the year 2015. The weakness was more pronounced during the second half of the year in which growth fell to an unexpected 2.8 percent. Overall, the global economy registered a disappointing growth of just 3 percent, which is 0.4 percent lower than in the brvious year.

The slowdown in the economy was mainly on account of the weak growth in Advanced Economies, moderate slowdown and rebalancing in China, weakness in oil exporting countries, severe macro-economic conditions in Brazil and other non-oil commodities exporting countries, recession in Russia and its spillover to other Commonwealth of Independent States, declining capital flows to Emerging Market Economies (EMEs) and the overall slowdown in investment and trade. The geo-political tensions in some countries in Middle-East, Sub-Saharan Africa and CIS also adversely impacted the global growth.

Global economy is expected to remain on a subdued trajectory in FY 2016-17. The Emerging Market Economies (EMEs) are likely to continue driving most of the world's growth, but this growth is projected to remain lower than the average growth in the past decade. China is expected to exhibit further slowdown of around 0.4 percent as its economy continues to shift from manufacturing and investment. Oil and other commodity exporting economies are estimated to face a further downturn, as the prices of commodities decrease further. Among the Advanced Economies, the United States is projected to grow at a moderate pace of 2.4 percent. The Euro region is also expected to continue its modest recovery, with the favorable effects of lower energy prices, a modest fiscal expansion and supportive financial conditions. Japan, however, may face further brssure as the scheduled increase in consumption tax takes effect. Overall, the global economy is forecast to grow at a modest 3.2 percent, with substantial downward risks to the projections.

The Domestic Economy

The domestic economy improved significantly during FY 2015-16 as the GDP grew at a very imbrssive 7.6 percent. This growth was achieved despite a subdued global demand and two consecutive below-normal monsoons that impacted farm output negatively.

The agriculture sector grew at 1.2 percent compared to the advance estimate of 1.1 percent. The sector had contracted by 0.2 percent in the brvious year. Manufacturing grew at 9.3 percent, slower than the advance estimates of 9.5 percent but much higher than the brvious year's figure of 5.5 percent. The consolidated services sector, however, grew at 8.8 percent only, as compared to 9.4 percent in FY 2014-15. Private final consumption - a proxy for private demand - grew at 7.4 percent compared to 6.4 percent in the brvious year.

Inflation, during FY 2015-16, remained modest and within the RBI's range. Retail inflation as measured by Consumer Price Index (CPI) eased from 5.3 percent in March 2015 to a low of 3.7 percent in July -August 2015, and increased subsequently, to 4.8 percent in March 2016. Retail inflation, based on CPI, averaged 4.91 percent lower than the 5.97 percent seen during FY 2014-15. Inflation based on Wholesale Price Index stood at -0.85 percent in March 2016 as compared to -2.33 percent during the corresponding month of the brvious year.

Maintaining its fiscal stance, the Government was able to contain its fiscal deficit to the budgeted level of 3.9 percent of GDP for the financial year. The Current Account Deficit (CAD) narrowed in the third quarter of the fiscal, mainly on account of a lower trade deficit. The CAD declined to $7.1 billion (1.3 percent of GDP) in Q3 of 2015-16 as against $7.7 billion (1.5 percent of GDP) in Q3 of 2014-15 and $8.7 billion (1.7 percent of GDP) in Q2 of 2015-16. The strong foreign direct investment inflow into the Indian economy sufficiently covered the CAD, resulting in accretion in foreign exchange reserves to US $355.55 billion as on 25th Mar '16.

Going forward, the Indian economy is projected to grow at 7.6 percent, the fastest amongst all the major economies. Buoyed by a normal monsoon, the agricultural sector is expected to bolster growth to 2.6 percent compared to 1.2 percent in FY 2016-17. The headline CPI inflation is projected to be moderate, at around 5 percent, the target set by RBI under the Monetary Policy Framework Agreement (MPFA). The increased consumption demand from implementation of the 7th Pay Commission recommendations, and the continuing monetary policy accommodations, are also likely to add to the projected growth. The strong commitment of the Government to achieve fiscal targets, its thrust on boosting infrastructure and the measures announced in the Union Budget 2016-17 to transform rural sector, are amongst the various other factors that are expected to bolster growth. On the other hand, the persisting corporate sector stress, under-utilization of organized industrial sector, fading impact of lower input costs in manufacturing, the risk aversion in the banking system, and the weaker global growth and trade outlook, brsent formidable downward risks to the projected growth.

Monetary and Liquidity Measures

On the basis of an assessment of the current and evolving macro economic situation, the RBI in its second bi-monthly monetary policy for 2016-17 decided to:

• keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.5 per cent

• keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4.0 percent of net demand and time liabilities (NDTL); and

• continue to provide liquidity as required but progressively lower the average ex ante liquidity deficit in the system, from one per cent of NDTL to a position closer to neutrality.

Consequently, the reverse repo rate under the LAF remained unchanged at 6.0 per cent, and the marginal standing facility (MSF) rate and the Bank Rate stayed at 7.0 per cent.

J&K's Economy

The J&K State's economy during FY 2015-16 witnessed a reasonable increase in economic activity as people resorted to savings, insurance claims and debt to re-establish businesses and livelihood. Construction both by government and individual households took the center stage and demand for skilled labor, coupled with a demand for steel, construction material and equipment remained buoyant throughout the year. In the brvious financial year, the State, due to the colossal damage by floods, had registered a negative growth of -1.57 percent in the GSDP. However, in FY 2015-16, the State registered an imbrssive growth of 7.9 percent, at constant prices, with the service sector leading the contribution among sectors. Agriculture remained slightly sluggish due to market fluctuations in apple and walnut. The industry sector showed improvements with substantial contribution from the construction and real estate segments.

In the State's latest budget for FY 2016-17, the total receipts were estimated to be Rs. 61,1681 crore. Of these, Rs. 51,460 crore were revenues and Rs. 10,221 crore were the borrowings. The total expenditure was estimated to be Rs. 64,669 crore during 2016-17. Of this, the capital expenditure would be Rs. 19,694 crore and revenue expenditure Rs. 44, 975 crore. Under the Prime Minister's Development Plan (PMDP), an amount of Rs. 1197 crore was received by the State for providing assistance in respect of completely/ severely and partially damaged houses. The release of funds was provided to individual beneficiaries under the Direct Benefit Transfer mode through the concerned District Development Commissioners. Certain categories of uninsured and small traders affected by the floods, who had not received any assistance either from banks or other financial institutions, were also provided assistance through the Chief Minister's Flood Relief Fund. A total amount of Rs. 101.89 crore was distributed by the State Government in the last year among around 40,000 small traders whose turnover was up to Rs. 5.00 lakh.

The long term objective of the Government is the development of the State's considerable hydro potential, through the PPP model. The Government announced its desire to remove the impediments to the investments in small hydel projects by bringing in a more investor-friendly policy. In its budget announcements, the Government declared that all industrial estates in the State shall be reorganized to function as a corporate entity. The State Government also announced plans for Joint Venture opportunities to the Top Ten IT companies of the State through the J&K E-Governance Agency (JAKEGA) or a SPV. The State Government also earmarked Rs. 800 crore under the PMDP, for extending interest subvention support to the trading and manufacturing units, whose borrowal accounts have been restructured by banks after the September, 2014 floods. The J&K Government also proposes to set up Business Incubators for sunrise industries in the cities of Srinagar and Jammu and provide financing, branding and marketing support to the entrebrneurs.

The J&K Government has planned a number of measures for the development of the handicrafts industry. These include, providing funds for 6,000 looms to help the carpet industry improve its weaving efficiency, creating a pashmina testing, certification and labeling laboratory which can certify handmade products on a larger scale and a sustained promotional campaign to create mass awareness about certification and labeling of handmade crafts of Kashmir.

In its last budget, the J&K Government announced a number of measures for the welfare of woman and the girl child. Continuing with this endeavor, the Government, in its budget for FY2016-17 announced plans for the creation of two Entrebrneur Development Centres, at Srinagar and Jammu, to help, guide and train, aspiring women entrebrneurs. The J&K Government also declared that 10 per cent of land in industrial estates will be reserved for women entrebrneurs.

The Banking Sector

The banking sector recorded a slowdown in balance sheet growth for the fourth year in a row in FY 2015-16. The slowdown was on account of a sluggish credit off take that slipped to single-digits during the year. Profitability also remained low, mainly on account of the deterioration in the asset quality.

The credit off take slowed down to 9.3 percent in FY 2015­16 from 9.8 percent recorded in FY 2014-15. The poor earnings growth by companies, slow pace of investments and risk aversion of banks due to rising bad loans pulled down credit growth during the year. Similarly, the growth in deposits of scheduled commercial banks (SCBs) at 8.6 percent in FY 2015-16 was much lower than the growth at 10.7 percent in the brvious financial year.

NPA's recorded a big surge in FY 2015-16 and increased up to Rs. 4.76 lakh Crores at the end of the financial year. Twelve state-run banks posted combined losses of Rs.20,643 crore in the March quarter, due to a surge in provisions for bad debt. The cumulative loss of 20 state-run lenders stood at Rs. 14,000 Crore during Q4 of FY 2015-16.

Since the decline in asset quality has been a key area of concern for the banking sector, the Government introduced a number of debt recovery measures such as Joint Lender's Forum, Structured Debt Restructuring (SDR), 5/25 refinancing scheme for extension of tenure in case of infra loans, and the Ujwal Discom Assurance Yojana (UDAY) scheme for salvaging loans taken by debt-ridden and loss-making SEBs. These measures have given banks more arsenal in their fight to bring down the quantum of bad loans. However, these measures come with their own share of challenges. In the case of SDRs, the banks have been empowered to convert debt into majority equity holding, change the management if required, or sell assets to recover their dues. Now, finding appropriate buyers at the right price for assets within 18 months can be a daunting task, especially in a debrssed environment. In the power sector, where PSBs have a huge exposure, the effectiveness of the UDAY scheme will be dependent on the states taking over the loans of SEBs. This can limit the availability of state resources for other development programs. And with states such as Uttar Pradesh and Tamil Nadu going to the polls soon, there is a likelihood of tariff hikes not being implemented, thereby putting a spanner in the works and raising doubts on the success of the scheme. Furthermore, with a large amount of bonds flooding the market (SEBs have an accumulated debt of Rs. 4.3 trillion), the appetite of the markets for these bonds is bound to be impacted. Therefore, the PSB's bad loan problem cannot be immediately wished away as the recovery measures will take time to yield results

A fresh plan for recapitalization was also introduced as part of the seven-point plan with the proposed capital infusion in PSBs, following a performance and need-based approach to the tune of Rs. 70,000 crore during the period 2016-2019. This capital support would be vital for PSBs in the light of their weakening capital positions and would enable them to adopt the Basel III framework. However, this is less than the total capital requirement of Rs. 1.8 trillion estimated by the government over the next four years. The government hopes to raise the balance amount of Rs. 1.1 trillion by divesting its stake in PSBs. However, this seems difficult in the current debrssed market, particularly with disproportionate increase in the bad loans in PSBs.

J&K Bank - Performance and Prospects

FY 2015-16 was a very challenging one for the Bank. Throughout the year, the Bank was confronted by a surge in non-performing assets which increased from Rs. 2764.08 crore at the beginning of the year to Rs. 4368.62 crore on March 31st, 2016. Consequently, the gross NPA's at the end of the year stood at 8.32 percent of advances. NPAs, however, were brdominantly limited to some big corporate accounts; an industry-wide phenomenon on account of persistent weakness in the corporate earnings. The J&K State, the major contributor of retail credit, however fared much better with GNPA at 3.5 percent.

For FY 2015-16, the impetus of the Bank remained on cleaning the balance sheet to make it stronger and healthier for the future. As such, the Bank decided to settle for lesser profits at Rs. 416.04 crore and instead, apportioned a substantial percentage of operating profits towards floating provisions, so as to have a strong cushion against future uncertainties.

In spite of the subdued economic environment at the national level and a stifled economy at J&K State level which is still recovering from the aftermath of the floods, the Bank's credit growth for the financial year stood at 12.58 percent which is much higher than the industry average credit growth of 9.3 percent. During the year, the Bank consciously avoided high cost deposits and instead focused on low cost CASA deposits. This resulted in improvement in Cost of Deposits as well as improvement in Net Interest Margins. For FY 2015-16, the cost of deposits of the Bank stood at 6.34 percent compared to 6.74 for the past financial year. Similarly, NIM stood at 3.85 percent compared to 3.81 percent in FY 2014-15. CASA deposits, as a percentage of total deposits, increased from 41.79 percent in 2014-15 to 44.13 percent in FY 2015-16.

The Bank remained well capitalized with an overall Capital Adequacy Ratio (CAR) of 11.81 percent as on March 2016, computed under Basel III norms, which is well above RBI stipulated norm of 9.625 percent. Of this, the Common Equity Tier I stood at 10.60 percent against the minimum regulatory requirement of 7.00 percent.

Going ahead, the Bank foresees better economic prospects in the home State of J&K for FY 2016-17. As such, the Bank has targeted a credit growth of 22 percent in the J&K State. Focus shall be on Medium, Small and Micro Enterprises, Trade, Agriculture, Tourism and various other services. The J&K State Government, in its budget for FY2016-17, has ear marked high density apple orchard plantations as one of its focus areas. Accordingly, J&K Bank has designed a customized product for financing such orchards. The Bank expects a substantial credit flow into this sector in the current financial year as well as in the subsequent ones. For the rest of the country, the Bank shall focus on rebalancing the portfolio mix towards a lower risk profile.

The policy of branch expansion in J&K State particularly in un-banked and under-banked areas, will be continued. These branches have proven to be substantial contributors of low cost CASA deposits for the bank. Against the CASA deposit ratio of 44 percent for the bank and 53 percent in overall J&K State, the CASA deposit ratio of these branches has remained at a very healthy 70 percent. Accordingly, the bank plans to establish 228 new branches in J&K State, out of the total 248 branches planned for the current financial year.