Key risks to the economy's prospects stem from global headwinds: RBI report
Global headwinds pose the biggest risks to the outlook for the Indian economy, the Reserve Bank of India said in its half-yearly Financial Stability Report on Thursday. While domestic macroeconomic stability is anchored by declining inflation, consistent fiscal consolidation and a modest current account deficit, the global scenario is characterized by low growth, high public debt and geoeconomic uncertainties. The report said the global financial system has become more resilient since the 2023 banking crisis, but prolonged tight monetary policy and a further economic slowdown could challenge financial stability.
The International Monetary Fund (IMF) has forecast that global growth would slow to 3 percent in 2023 and 2.9 percent in 2024, both below the pre-pandemic (2000-2019) average of 3.8 percent. This moderation in growth is expected to coincide with a substantial slowdown in global trade growth, which is expected to decline from 5.1 percent in 2022 to 0.9 percent in 2023. Although a recovery to 3.5 percent is expected in 2024, this would still fall short. of the average growth observed in the period 2000-2019, which was 4.9 percent.
On the domestic front, real GDP grew by 7.6 percent in the second quarter of the current fiscal year, driven by robust consumption and investment growth that offset the decline in exports. However, there are potential risks associated with the global environment, including the slowdown in global trade, tightening global financial conditions, increasing fragmentation and geopolitical tensions, all of which pose contingent threats to external demand. In addition, the impact of El Niño poses a potential challenge to agricultural production and food prices.
Meanwhile, an extended period of high interest rates is about to assess the resilience of the banking sector, the report said. There are renewed concerns about asset revaluations, reminiscent of the challenges faced during the March 2023 turmoil.
The report notes that the rise in interest rates has benefited banks by improving their net interest margins (NIM), with faster transmission to returns on assets compared to the cost of funds. However, as the interest rate cycle approaches its peak, banks are expected to face profitability challenges due to increasing valuation losses, increased risks to asset quality and moderation in credit growth.
Recent market expectations indicate an impending shift in monetary policy, with increasingly anticipated transitions from aggressive pauses to rate cuts. However, the report underlines concerns about high debt burdens of both the public and private sectors, coupled with the rising cost of debt servicing, posing risks to debt sustainability and fiscal health. In addition, global banks face potential valuation losses in their bond portfolios. Overall, heightened risks to global financial stability continue as market participants adjust their outlooks based on incoming data, resulting in a sharp rebalancing of expectations and the subsequent repricing of financial assets.
The report emphasized that exchange rate stability has helped absorb external shocks and mitigate the impact of global spillovers on domestic macroeconomic and financial stability.
The report states that advanced economies and emerging market and developing economies (EMDEs) are struggling with persistently high public debt-to-GDP ratios, which are exceeding pre-pandemic levels. The projection indicates that global public debt will reach 93 percent of global GDP in 2023, with an annual increase of one percentage point, and reach almost 100 percent of GDP by 2030. Amid this unabated expansion, public debt is expected to reach 116.3 and 78.1 percent of GDP for AEs and EMDEs, respectively, in 2028.
Nationally, the central government debt-to-GDP ratio is expected to decline from 62.8 percent in 2020-21 to 57.4 percent in 2023-2024. However, the debt burden is expected to remain high. In 2022-23, the states' gross fiscal deficit (GFD) stood at 2.8 percent, lower than the budgeted estimate of 3.2 percent. A notable reduction in revenue deficits has been the main driver of this fiscal consolidation. For the period 2023-2024, the states have budgeted a GFD-to-GDP ratio of 3.1 per cent, well within the Centre's limit of 3.5 per cent.
Despite these efforts, states' outstanding debt still exceeds 20 percent of the state's Gross Domestic Product (GSDP), which is higher than the limit recommended by the FRBM Review Committee (2018). The larger states in particular have a debt ratio of more than 35 percent of GDP, which could potentially lead to repayment pressure in the medium term. Moreover, the restoration of the legacy pension scheme (OPS) by some states may impact their ability to undertake development and capital expenditure.
India's government debt and deficit are expected to remain above the global average.
Despite the recent increase in financial liabilities, household debt in India remains significantly lower than in other emerging market economies. Consequently, the risk of defaults due to the greater exposure to higher mortgage payments and variable interest rates is limited in India. The current level of household debt in the country does not raise any systemic concerns. Recent data shows that the household non-financial sector (HNFS) increased to 7.0 percent of GDP in the fourth quarter of the 2022-2023 financial year, compared to 4.0 percent in the previous quarter. This indicates a normalization trend towards the long term before the pandemic. -term pattern.
In terms of corporate bonds, banks and legal entities together accounted for almost 61 percent of total subscriptions. Public issues had a predominant participation of residents.
The report highlighted that recent proactive regulatory measures are expected to alleviate the accumulation of stress arising from the increasing number of unsecured loans and the rapid expansion of consumer credit. Contingent risks persist in the form of global spillovers, increasing interconnectedness within the domestic financial sector and the expanding role of non-banking financial companies (NBFCs) in the financial services industry. However, the combination of strong bank capital, prudent supervision and robust balance sheets should position the domestic banking system to withstand shocks and support the productive needs of the economy.
First print: December 28, 2023 | 11:57 PM IST