Tuesday, December 27, 2011

Financial Stability Report: RBI

On 22 December, 2011 the Reserve Bank of India published the Financial Stability Report (FSR). The Report read in totality would suggest that though the Indian Economy (and especially the financial system) remains stable, there exists some disconcerting macroeconomic issues. The core issues include the Euro Zone Crisis, Slowdown in the US, inflation and elevated oil prices. The relevant portion of the report reads as under:

“Global risks have increased since the publication of the third FSR in June 2011. Heightened uncertainties arising from the deepening sovereign debt crisis in the Euro Area and slowdown in the US pose downside risks for the global economy and for India through trade and finance channels and, therefore, need to be monitored closely. External sector risks are likely to increase. Elevated oil prices also pose downside risks to global recovery and have significant implications for domestic inflation. The profit margin of the corporate sector has dipped, indicating its reduced pricing power in the face of rising raw material and interest costs, domestic and global.” (emphasis mine)

In so far as the financial markets are concerned, the report acknowledges that there has been a significant deterioration from June 2011 onwards and the situation could worsen further. The following portion is apposite:

“Systemic risks facing the global and domestic financial system have heightened of late. There is significant deterioration in financial market conditions, for both sovereign and non-sovereign sectors, as a result of downgrades by rating agencies and poor economic outlook. Funding markets for short and long term finance in most currencies have become stressed with financial and non-financial firms facing significant challenges in raising longer term funds. Financial markets are trading with a downward bias on the belief that effectiveness of monetary and fiscal intervention is considerably lower in advanced economies. High levels of volatility are unnerving market participants abroad. The fallout of these developments is starting to impact overseas borrowings by financial and non-financial firms in India. The Indian equity and foreign exchange markets witnessed large corrections attendant with high volatility. The resultant impact on investor sentiment has been offset partially through a recovery in Foreign Direct Investments (FDI) flows this year. Higher than expected government borrowings, coupled with loss in growth momentum, could stress domestic financial markets though.” (emphasis mine)

On the soundness and resilience of the financial institutions the report concludes that there has been an increase in Non Performing Assets (NPAs) especially sectors such as priority sector, retail, real estate and infrastructure. The relevant part reads as under:

“The recent regulatory prescriptions for European banks have brought in fears of deleveraging. The direct impact on Indian banks, though, is expected to be limited. The banking system remained sound with CRAR and core CRAR well above the regulatory minimum and NPA ratios that compared favourably with the major advanced countries as well as peer EMEs. Continuous decline in CRAR and deterioration in asset quality, however, indicated that the risks were rising for the banking sector; even as credit growth decelerated and slippages outpaced credit growth. The major sectors that contributed to the increasing trend in NPAs were the priority sector, retail, real estate and infrastructure. In the infrastructure segment, the power and telecom sectors saw increased impairments and restructuring. The banking stability map and indicator also depicted increase in vulnerabilities in the Indian banking sector (emphasis mine)

There have been mixed reactions on the report. Some commentators believe that the FSR is ‘reassuring’ whereas others argue that there exists a ‘brewing banking crisis’.

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