In the ‘collective assessment’ of the Sub-Committee of the Financial Stability and Development Council on current and emerging risks to the stability of the Indian financial system, our financial sector was in good shape as of March 2024. So says the Reserve Bank of India’s (RBI) Financial Stability Report (FSR) released last Thursday.
Though the term ‘financial stability’ encompasses much more than the stability of the banking sector, the FSR focuses on banks on the grounds that our financial system is “bank dominated and, therefore, sound health of the banking system is a sine qua non for preserving financial stability.”
The good news is that banks’ balance sheets are “consistently improving, with multi-year low non-performing asset (NPA) ratios, higher provisioning, stronger capital positions and robust earnings,” thereby “catalysing a broad-based and sustained credit expansion.”
Better still, the Indian economy is “poised to sustain resilient growth anchored by macroeconomic and financial stability.” Given the close link between the health of the banking sector and that of the overall economy, this is doubly reassuring. Does this mean all is well?
Not quite. Beneath its apparent gloss, the FSR has disquieting stuff on many fronts, notably a decline in our gross savings rate to 29.7% of gross net disposable income, and within that, a fall in household savings from 20% during the period 2013-22 to 18.4% in 2022-23.
While we celebrate the emergence of India as the world’s fifth biggest stock market, with the market cap of listed stocks touching $5 trillion, the decline in the share of net financial savings in total household savings is puzzling.
From an average of 39.8% during 2013-2022, this share is now down to 28.5% in 2022-23, while a rise in financial liabilities has resulted in net financial savings falling to 5.3% of GDP during 2022-23, down from an average of 8% during the period 2013-2022. This is a matter of concern and deserves monitoring, says the latest FSR.
Equally disturbing is the decline in foreign direct investment (FDI). It is hard to share the FSR’s view that FDI flows have only “moderated” when they’ve dropped from $28 billion in 2022-23 to $9.8 billion in 2023-24. In the same period, foreign portfolio investment (FPI) flows shot up from minus $4.8 billion to $44.6 billion, a difference of nearly $50 billion.
Remember, FDI inflows are preferred over easy-come-easy-go FPI inflows or ‘hot money.’ True, the FDI decline may be partly due to higher repatriations, but its magnitude is a cause for concern. Especially since the inclusion of government securities in the JPMorgan global bond index will likely attract more debt inflows, further skewing the balance against FDI.
That’s not all. The FSR warns that some asset valuations could be stretched, since, unlike in the past when monetary tightening was associated with risk-off sentiment and softening prices, the latest bout has seen a “sharp increase in prices of relatively riskier assets.”
In such a scenario, “sudden shocks could precipitate stress that spreads contagiously across financial market segments through correlated sell-offs and band-wagon effects.” More so since the “growing importance of the role of non-bank institutions in financial intermediation and higher and hidden leverage could amplify stress even further in the face of large shocks.” Clearly, there is much in the report’s fine print that warrants more scrutiny. And possibly action.