In the latest edition of its half-yearly Financial Stability Report (FSR), the Reserve Bank of India (RBI) has pointed out that global risks and domestic macroeconomic risks continue to be the two most important factors affecting the stability of the Indian financial system. While there might not be anything new in that observation — recent FSRs have emphasised much the same factors — the June report has been prepared in the shadow of major debates about the appropriateness, timing and pace of the U.S. Federal Reserve’s impending decision to end its highly unconventional monetary policies. This expectation has created tremors in financial markets across the globe. The rupee tumbled against the dollar to fall below Rs.60 simply on the basis of unconfirmed reports that the Fed would be phasing out its ultrasoft monetary policy sooner than expected. Practically all major emerging markets have witnessed large-scale sell-offs in their currency, bond and equity markets. India’s external sector vulnerabilities have been exposed. A critical and even fatal dependence on fleet-footed capital flows is in evidence along with the paucity of policy measures to shore up the balance of payments on a more sustained basis. Two reports released on the same day as the FSR — a snapshot of external debt as of end March 2013 and the balance of payments assessment during the last quarter of 2012-13 — are not encouraging.

India’s external debt has risen by nearly 13 per cent over March 2012. Quite disconcertingly, there is an unhealthy bunching up of short-term loans due for repayment by March 2014. The current account deficit remains high at 4.8 per cent of GDP and has been a major factor behind the rupee’s recent depreciation. Many corporates who borrowed abroad have been reckless in not hedging their exchange rate risks and are thus contributing to macroeconomic instability. Risks to the banking sector have increased marginally over the past six months, with tight liquidity and deteriorating asset quality being the main causes. In the RBI’s estimate, if current macroeconomic conditions continue, the credit quality of banks could deteriorate but all of them have enough capital to withstand pressures. Life insurance products are dominated by single premium policies. There are question marks over the funding of some of the newly defined benefit plans and these could strain the insurers on the maturity dates. In an obvious reference to recent scams in certain banks, the FSR cites instances of mis-selling financial products, mostly insurance products and other wealth management services. The overall message from the seventh FSR is that while the financial system is stable for now, it faces increased risks from home and abroad.

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