OPEN APP
Home / Opinion / Views /  Three economic risks in need of mitigation plans

In recent times, many central banks across the world have redone their internal wiring as they abandoned traditional parsimony to tackle economic exigencies. Their attempts to marshal growth in output through extended periods of low interest rates and liquidity infusion, without a clear sunset clause, has finally got markets edgy. The nervousness started showing after a nascent revival of economic growth collided with impaired capacities, resulting in incipient inflationary tendencies. With the US Federal Reserve recently indicating that it might start raising interest rates some time in 2023, the matrix of risks washing up on Indian shores suddenly looks much more complex and ominous. Looking out from his 18th floor perch, Reserve Bank of India (RBI) governor Shaktikanta Das has to watch out for risks transmitted from overseas markets as well as keep an eye out for those developing in the domestic economy.

The central bank’s latest Financial Stability Report (FSR) tries to acknowledge all of them. Some are easily recognizable. As the Indian economy picks up slowly and unevenly, in step with the fluctuating pace of covid vaccination and the asymmetric opening up across regions, it is clear that a return to pre-pandemic levels of economic activity will take longer than earlier thought. Dented supply-side capacities will require time to rebuild and reactivate. The demand side is dependent on rising employment rates and households finding the confidence to convert precautionary savings into consumption. But three risks stand out in the report that impinge on systemic and financial stability, and need some attention. Two emanate from overseas: commodity inflation and retrenchment of global capital flows. The third risk has been festering at home: the deepening fault lines of our domestic banking sector.

There is no clear risk-mitigation strategy in sight yet, though some disparate voices have emerged that could exacerbate the risks we face. One of them relates to using RBI’s swelling reserves of foreign exchange for infrastructure investment, which is decidedly inadvisable; our chest of foreign currency will be required to counter any ‘taper tantrum’ if and when capital inflows reverse. The second risk of ‘imported’ commodity inflation will need close monitoring and more adept handling; our surveys already indicate rising inflationary expectations among households, and RBI should be flexible on its rate policy. Protracted low interest rates have helped secure neither capital expansion nor economic growth, but aided indebted wholesale borrowers. The main worry, though, is the banking sector’s health and the balance-sheet damage that lurks behind extended regulatory forbearance. RBI’s stress tests on banks’ non-performing assets and capital backing seem to exude a degree of misplaced confidence. Capital will be key to riding out a bad-loan crisis; if credit demand picks up in tandem with our economic opening up, there are doubts whether banks will have adequate capital to not just back new lending, but also cover a rising tide of bad loans. The government, the sector’s main provider of capital, has limited resources that are being pulled in different directions. The near-term solution, therefore, is perhaps not outright bank privatization—which seems unfeasible at this juncture—but the sale of small parcels of fresh equity to retail and institutional investors. This way, state-held banks can shore up capital and the government’s stake in them would get a better valuation. It’s a win-win option.

Subscribe to Mint Newsletters
* Enter a valid email
* Thank you for subscribing to our newsletter.

Never miss a story! Stay connected and informed with Mint. Download our App Now!!

Close
×
Edit Profile
Get alerts on WhatsApp
My ReadsRedeem a Gift CardLogout