High inflation, falling growth risks to macro stability: RBI

Financial Stability Report says global risks remain elevated

Buffeted by global headwinds and uncertainties in domestic policies, risks to the country’s macroeconomic stability have risen on the back of fall in domestic savings, persistenly high inflation, regulatory and environmental issues, said the Reserve Bank of India (RBI) in a report released on Friday.

Those mentioned afore have caused a fall in investment demand and moderation in consumption spending leading to decline in growth, said the sixth issue of the Financial Stability Report (FSR) of RBI, which is being released in an environment of global macroeconomic instability and uncertainty.

Economic growth in India has moderated in recent quarters, while growth, however, needs to accelerate if the momentum of poverty reduction, employment generation and payoff from the demographic dividend is to be accelerated, the report said. It reflected the collective assessment of the Sub-Committee of the Financial Stability and Development Council (FSDC) on risks to financial stability.

Further, FSR said global risks remain elevated due to delays in resolution of issues like the European sovereign debt crisis and the imminent US fiscal cliff. External sector imbalances remain a worry, it said adding rising gold imports have worsened the current account deficit.

Domestic savings have been falling. As such, a lower proportion of household savings is channeled towards financial products. The financial sector dominated the corporate bond issuance, reducing effective disintermediation. Financial markets though remained largely stable but the exchange rate volatility was high relative to that of some peers and advanced economies. Dwelling on the corporate sector, the report said its ability to service debt has been falling since 2009-10. Some industrial groups with greater exposure to key infrastructure sectors like power have witnessed high growth in leverage in recent years.

RBI’s latest Systemic Risk Survey conducted in October 2012 among bankers, consultants, academicians etc revealed concerns about evolving global risks such as the fall in global growth and sovereign risk/contagion and a host of domestic factors like increasing fiscal deficit, deterioration in growth outlook and bank asset quality. However, respondents remained confident about the stability of the domestic financial system.

It also highlighted that distress dependencies between banks have remained largely unchanged in the period under review. While there has been no major shift in the pattern of interconnectedness or contagion risks in the system in the recent periods, an assessment of the impact of the liquidity contagion in the Indian banking system has been attempted for the first time in this issue of the FSR. Asset quality of the banking system came under stress during the period under review with greater recourse to restructuring. Banking sector, however, remained resilient to credit, market and liquidity risks and capable of withstanding macroeconomic shocks, given their comfortable capital positions. Regulatory reforms, the report continued, initiated in the wake of the global financial crisis are in various stages of implementation across countries. Some reforms may have unintended consequences for emerging markets. The recent deterioration in asset quality and regulatory changes requiring higher provisions may pose challenges for banks in India as they migrate to Basel III.

Furthermore, it said that there are challenges in migrating all OTC derivative transactions to central clearing given problems in standardisation, insufficient liquidity and opacity in pricing information of some products/markets.

Financial Inclusion, Financial Literacy and Consumer Protection have been recognised as inter-twining threads in pursuit of financial stability. This edition of the FSR, for the first time, discusses the various regulatory initiatives to achieve this objective.