RBI says risks to financial stability on the rise

The Reserve Bank on Thursday said the sovereign debt crisis in the Eurozone has increased the risks India's financial stability in 2012.

Mumbai: The Reserve Bank on Thursday said the sovereign debt crisis in the Eurozone has increased the risks India's financial stability in 2012.

In the Financial Stability Report released here, the central bank also said the country faces the risk of lower growth in 2012-13 if the monsoon is below average.

Noting that global and domestic outlook have worsened since last December, the report said, "The combined effect of the dismal global macroeconomic situation and the muted economic performance on the domestic front has caused marginal increase in risks to stability.

"The Euro area sovereign debt problem is continuing to weigh on global recovery. Although slowing global growth has dampened commodity prices, heightened risk aversion and the resultant slowing of capital flows are likely to adversely impact emerging and developing economies."

"While growth has clearly slipped, inflation risks remain. Despite moderation in core inflation, the persistence of overall inflation, in the face of significant growth slowdown, points to serious supply bottlenecks and sticky inflation expectations," the report further said.

Warning that weakness in investment in particular has implications for the near and medium-term growth outlook, the report said: "Headwinds from the global economy will continue to impact domestic growth in the coming quarters.

"Going forward into 2012-13, downside risks to growth are likely to persist, especially if the monsoons are significantly below long period average," it said.

On the risks from rising current account deficit (CAD) -- likely to touch 4 percent in FY12 -- the FSR said: "A widening CAD in the face of worsening global economic and financial conditions and muted capital flows has exerted downward pressure on the rupee.

"Chances of increasing capital inflows depend on both global conditions, particularly a credible resolution of the Euro area situation, and an improvement in the domestic investment climate."

It said the key risks to domestic economy seem to arise from global sovereign debt problem and risk aversion, domestic fiscal position, widening CAD and structural aspects of food inflation.

The report added that uncertain global situation, rising risk aversion and slowing capital inflows are impacting emerging and developing economies in general, and pose challenges to the domestic growth and balance of payments outlook.

On the rising debt burden of corporates, it said risks from the corporate sector balance sheets have remained elevated due to relatively unfavourable domestic and external macroeconomic environment such as subdued consumption and investment demand, rising costs of inputs, deceleration in exports and risks from unhedged foreign currency.

On the positive side, the FSR said risks in the household sector have moderated.

The report said, "Growth in the advanced economies remained sluggish in Q4 of 2011 and Q1 of 2012. The IMF as well as the European Commission have indicated that the Euro area will undergo a mild recession in 2012. The emerging economies are also expected to slow down."

It added that slowdown in the Euro area is spreading through trade, finance and confidence channels to other advanced markets and to emerging and developing markets.

Noting that the pain is not over yet, the report warns that in the short-run, fiscal consolidation measures, especially in the Eurozone, could impact demand and growth adversely.

The recent string of rating downgrades of the Euro area sovereigns and banks could raise borrowing costs. Growth, both in the Eurozone and in other parts of the world, is also likely to be affected by deleveraging by EU-based banks, and emerging and developing economies are especially vulnerable to the spillovers of the accommodative monetary policies in the West in general, and the Eurozone in particular.

"There are concerns that the recession in the Eurozone may be used by countries to scale back or defer fiscal consolidation measures, especially in the current political climate."

Quoting an IMF report, the FSR said: "Should growth slow further, countries with fiscal space should allow automatic stabilisers to operate freely and allow deficit to rise to avoid excess fiscal contraction, which could worsen the conditions."