The Financial Stability Report (FSR), December 2024 released by the Reserve Bank of India has presented an analysis of current and emerging risks to the stability of the Indian financial system based on contributions from all financial sector regulators. It mainly covers issues and data related to Macro Financial Risks faced by the Indian economy, Soundness and Resilience of Financial Institutions and Regulatory Initiatives in the Financial Sector. This article largely focuses on the macro financial risks and how the Indian economy and its financial system has generally been dealing with it and moving ahead, showing great deal of resilience and maintaining its growth rates at high trajectory.
Factors strengthening the Global Economic Outlook
Resilience
In the year 2024, the global economy faced strong political and economic policy uncertainty largely due to persisting conflicts and an environment of fragmenting international trade and tariffs. Yet it showed consistent resilience.
Decline in inflation
Inflation showed declining trend in many countries and the best part is that this trend is projected to continue to keep inflation within the targets which may brighten the global prospects of enhancing purchasing power for the individuals and corporates.
Support for economic activity
As inflation is projected to be within the targets pursued by the central banks in the leading economies of the world, the monetary policy may find the space to continue to support economic activity, and so the financial conditions may be expected to remain easy and contribute to an improvement in the trajectory of global GDP pulling it out from a prolonged phase of low growth. Robust labour market and sound financial system are also expected to contribute to the congenial conditions for this turnaround.
Factors challenging the Global Economic Outlook
Despite so many positive forces strengthening the global economy, the Financial Stability Report December 2024 released by the RBI, projects that the medium-term outlook remains challenging, with downside risks due to the possibility of the occurrence of the following areas of vulnerabilities in the global financial system:
Intensified Geopolitical conflicts
One and the foremost reason seems to be widening of geopolitical conflicts which have kept financial markets on the edge making them prone to sudden bouts of volatility and policy uncertainty. RBI observes that upside risks to inflation from further escalation in geopolitical conflicts and growing economic fragmentation persist due to possibility of rising commodity prices and supply shocks.
Increased vulnerability in financial markets
Several equity markets rallied in the second half of the year 2024, indicating stretched equity valuations, with many stock indices trading at high price-to-earnings (P/E) ratios relative to historical levels. Corporate bond market valuations also remain high as credit spreads which is measured by the difference in the yield between corporate bonds and similar- maturity government bonds, is at lower level relative to historical distributions. High equity valuations and low credit spreads could be a source of vulnerability to financial stability, especially when market expectations turn volatile as happened, for instance, in the case of Japanese Yen (JPY) carry trade unwinding during August 2024. Besides, uncertainty about trade and industrial policies in the aftermath of major global elections, and potential tightening of financial conditions may drag global output lower than what IMF has projected in its ‘World economic Policy, October 2024. Also, a massive surge in the crypto assets’ prices may have adverse consequences for macroeconomic and financial stability.
Other reasons
According to the Financial Stability Report, vulnerabilities are festering in the form of leveraged positions, stretched asset valuations, elevated levels of public and private debt and opaque fragilities in less regulated nonbank financial intermediaries. According to an IMF report, published in the month of October 2024, global public debt may exceed US$ 100 trillion by the end of the year 2024 which could be around 93 per cent of the global GDP. Particularly the U.S. and China are the main drivers of this surge which is expected to surpass 100 per cent of GDP by 2030. Besides, there are threats from new and emerging technologies and deterioration in environment, which may also contribute to the increased vulnerability in the markets.
Prospects for the Indian Economy 2025
In this backdrop of the uncertain global macroeconomic and financial environment, the Indian economy is reportedly exhibiting resilience and stability. The uncertainties posed by the downside risks in the global economy may be tackled by certain proactive measures by the financial sector regulators in India such as intensifying reforms and sharpening their surveillance even as the financial system seems strengthened due to robust earnings, low levels of impaired assets and capital levels of the banking system as well as of the non-banking financial companies (NBFCs) sector being well above the regulatory minimum.
Domestic Growth and Inflation:
During the first half pf the year 2024-25, real GDP growth moderated to 6.0 per cent from 8.2 per cent and 8.1 per cent growth recorded during first and second half of the year 2023-24 respectively. Despite the slowdown in the pace of economic activity in the first half of 2024-25, RBI projects that the real gross domestic product (GDP) may grow at 6.6 per cent in 2024-25.
However, inflation is at higher levels and thus it continues to be a priority in the determination of the monetary policy in the short and medium term. Further, extreme weather conditions such as unseasonal rains etc., if any, may pose risks to the food inflation dynamics. Also, global commodity prices’ surge may put pressures on inflation rates in India. However, a bumper kharif harvest and the robust prospects about rabi crops are likely to soften prices of food grains.
External Sector
Merchandise exports recorded growth of 2.2 per cent during April-November 2024, whereas merchandise imports rose by 8.3 per cent compared to the similar period previous year. The trade deficit, thus, increased to US$ 202.4 billion during this period from US$ 171.0 billion compared to the previous year.
In case of financial account, net foreign direct investment (FDI) inflows have slowed down on year to year basis. Besides, strong foreign portfolio investment (FPI) inflows in the first half of 2024-25 were followed by large outflows subsequently. However, up to December 12, 2024, net FPI inflow stood at US$ 12.7 billion during 2024-25 with net debt flows benefiting from India’s inclusion in multiple global bond indices. Both external commercial borrowings (ECBs) and non-resident deposit inflows were higher compared to the previous year. In a nutshell, capital flows exceeded the current account deficit (CAD) and contributed to accretion to foreign exchange reserves. As on December 20, 2024, India’s foreign exchange reserves of US$ 644.4 billion are the fourth largest in the world.
External sector sustainability seems satisfactory indicated by the foreign exchange reserves covering 99 per cent of the country’s external debt or nearly one year of merchandise imports as at end-September 2024. Moreover, around two-thirds of External Commercial Borrowings (ECBs) remain hedged.
Corporate Sector
The overall performance of listed private non-financial companies (NFCs) has remained steady this year so far with sales growth remaining stable at 6.2 per cent in the first half of the year 2024-25 compared to the previous year. Sales growth of manufacturing companies remained steady at 4.9 per cent during the first half of the year 2024-25, while the sales in the IT and non-IT services sectors, increased by 5.7 per cent and 9.6 per cent, respectively. In case of the listed private NFCs, debt serviceability improved during the first half of the year 2024-25 due to lower rise in interest cost relative to their earnings before interest and taxes. However, operating profit growth of manufacturing companies moderated to 4.3 per cent during the first half of the financial year 2024-25 due to rising staff and input costs on year-to-year basis.
Government Finance
The government has sustained its move towards fiscal consolidation as the gross fiscal deficit (GFD) was contained at 5.6 per cent (of GDP at current market prices) which was lower than the budget estimates (BE) of 5.9 per cent according to the provisional accounts (PA) of the central government for 2023-24. It is projected to go down further to 4.9 per cent in 2024-25 in line with the Budget estimates. The fiscal position of the central government has improved primarily due to broad-based growth in revenue receipts. There has been an increase in capital expenditure which indicates the government’s continued focus on improving the quality of expenditure to support investment and economic growth. The capital outlay (capital expenditure excluding loans and advances) is projected to increase by 16.7 per cent. Revenue expenditure is estimated to record a relatively modest rise of 6.2 per cent. As a result, the revenue expenditure to capital outlay ratio (RECO) is projected to fall to an all-time low of 4.0 during 2024-25 also in conformity with the budget estimates.
Household Finance
India’s household debt has been reported at 42.9 per cent of GDP (at current market prices) in June 2024. It has increased over the past three years, yet it continues to be relatively low compared to other EMEs. Also, the increase is driven by a growing number of borrowers rather than an increase in average indebtedness. An analysis of the nature of individuals’ borrowings shows that loans are primarily used for consumption, asset creation and for productive purposes. It has been observed that around two-thirds of the portfolio is of prime and above credit quality.
Financial Markets
Since the Financial Stability Report (June 2024), financial conditions are reported to have eased further due to improvement in system liquidity and the shift in monetary policy stance to neutral. This is also indicated by softening of short-term money market rates as well as yields on government securities and corporate bonds.
The Indian equity market rose to record highs in late-September 2024, but then there was some correction also due to slowdown in the corporate earnings growth and rising concerns about market valuation. However, it outperformed emerging market peers in 2024 with MSCI India Index recording a return of 19.5 per cent compared to 8.3 per cent for MSCI Emerging Markets Index (MSCI-EMI) as on December 12, 2024. This has led to increase in India’s weightage in the MSCI-EMI from 9.2 per cent in March 2019 to 19.9 per cent in November 2024
Summing up
Going forward, the RBI’s pursuit continues to focus on:
(a) preserving financial stability to support a higher growth path for the Indian economy,
(b) maintaining stability of financial institutions,
(c) ensuring systemic stability, and
(d) developing a modern financial system that is customer-centric, technologically leveraged and financially inclusive.
Amidst a challenging global macroeconomic environment, the Indian economy has continued to be on a strong growth trajectory underpinned by robust macroeconomic fundamentals. Therefore, even as the risks from global spillovers remain, the Indian financial system, supported by further improvement in balance sheet of banks and NBFCs, and strong buffers, is expected to remain sound and vibrant, according to the recent Financial Stability Report.