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Global headwinds pose the main risks to the outlook for the Indian economy, said the Reserve Bank of India in its bi-annual Financial Stability Report on Thursday. Although domestic macroeconomic stability is anchored by decreasing inflation, consistent fiscal consolidation, and a modest current account deficit, the global scenario is marked by low growth, high public debt, and geo-economic uncertainties. The report said that the global financial system is more resilient since the 2023 banking turmoil, but prolonged tight monetary policy and further economic slowdown could test financial stability.
The International Monetary Fund (IMF) has projected that global growth would decline to 3 per cent in 2023 and 2.9 per cent in 2024, both below the pre-pandemic (2000–19) average of 3.8 per cent. This moderation in growth is expected to coincide with a substantial deceleration in world trade growth, projected to drop from 5.1 per cent in 2022 to 0.9 per cent in 2023. Although a recovery to 3.5 per cent is projected in 2024, it would still fall short of the average growth observed during 2000-19, which stood at 4.9 per cent.
On the domestic front, real GDP expanded by 7.6 per cent in the second quarter of the current financial year, driven by robust consumption and investment growth that counteracted the decline in exports. However, there are potential risks from the global environment, including the slowdown in world trade, stricter global financial conditions, growing fragmentation, and geopolitical tensions, all posing contingent threats to external demand. Furthermore, the impact of El Niño conditions adds a potential challenge to agricultural output and food prices.
Meanwhile, an extended period of elevated interest rates is poised to assess the resilience of the banking sector, the report said. There’s renewed concern about the revaluation of assets, reminiscent of the challenges faced during the turmoil in March 2023.
The report noted that the rise in interest rates has benefited banks by improving their net interest margins (NIM), with a faster transmission to yield on assets compared to the cost of funds. However, as the rate cycle nears its peak, banks are expected to face profitability challenges due to increasing valuation losses, heightened risks for asset quality, and a moderation in credit growth.
Recent market expectations suggest an impending shift in monetary policy, with increasingly anticipated transitions from hawkish pauses to rate cuts. However, the report underscores concerns regarding elevated levels of both public and private sector debt, coupled with escalating servicing costs, posing risks to debt sustainability and fiscal health. Additionally, global banks confront potential valuation losses in their bond portfolios. Overall, the heightened risks to global financial stability persist as market participants adapt their outlook based on incoming data, resulting in a sharp realignment of expectations and the subsequent repricing of financial assets.
The report highlighted that the stability of the exchange rate has helped in absorbing external shocks and mitigating the impact of global spillovers on domestic macroeconomic and financial stability.
The report said that advanced economies (AEs) and emerging market and developing economies (EMDEs) grapple with persistently high public debt-to-GDP ratios, surpassing pre-pandemic levels. The projection indicates that global public debt is set to reach 93 per cent of world GDP in 2023, with an annual increase of one percentage point, reaching nearly 100 per cent of GDP by 2030. Amid this unabated expansion, public debt is expected to reach 116.3 and 78.1 per cent of GDP for AEs and EMDEs, respectively, by 2028.
Domestically, the Central Government’s debt-to-GDP ratio is anticipated to decrease from 62.8 per cent in 2020-21 to 57.4 per cent in 2023-24. However, the debt service burden is expected to remain high. In 2022-23, the states’ Gross Fiscal Deficit (GFD) stood at 2.8 per cent, lower than the budgeted estimate of 3.2 per cent. A notable reduction in revenue deficits has been the primary driver of this fiscal consolidation. For 2023-24, states have budgeted a GFD-GDP ratio of 3.1 per cent, well within the Centre’s limit of 3.5 per cent.
Despite these efforts, outstanding liabilities of states still surpass 20 per cent of Gross State Domestic Product (GSDP), exceeding the limit recommended by the FRBM Review Committee (2018). Larger states, in particular, exhibit debt ratios exceeding 35 per cent of GSDP, potentially posing redemption pressure in the medium term. Additionally, the reinstatement of the old pension scheme (OPS) by some states may impact their capacity to undertake developmental and capital expenditures.
India’s general government debt and deficit are anticipated to persist above global averages.
Despite the recent uptick in financial liabilities, household debt in India remains significantly lower than in other Emerging Market Economies. Consequently, the risk of defaults due to heightened exposure to higher mortgage payments and floating-rate interest is limited in India. The current level of household debt in the country does not raise systemic concerns. Recent data indicates that the Household Non-Financial Sector (HNFS) increased to 7.0 per cent of GDP in the fourth quarter of the financial year 2022-23 from 4.0 per cent in the previous quarter, signifying a normalization trend towards the pre-pandemic long-term pattern.
In terms of corporate bonds, banks and body corporates jointly accounted for nearly 61 per cent of the total subscriptions. Public issues saw predominant participation from residents.
The report highlighted that recent proactive regulatory measures are anticipated to mitigate the accumulation of stress arising from increasing unsecured loans and the rapid expansion of consumer credit. Contingent risks persist in the form of global spillovers, growing interconnectedness within the domestic financial sector, and the expanding role of Non-Banking Financial Companies (NBFCs) in financial services provision. However, the combination of strong banking capital, regulatory prudence, and robust balance sheets should position the domestic banking system to withstand shocks and support the productive needs of the economy.
First Published: Dec 28 2023 | 11:57 PM IST
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