>RBI releases First Financial Stability Report : Says Limited Risk to Financial Stability, but Monitoring Required on an Ongoing Basis

As announced in the Annual Policy Statement of April, 2009 the Reserve Bank of India established a Financial Stability Unit in August, 2009. The Second Quarter Review of Monetary Policy in October, 2009 made specific mention of a periodic Financial Stability Report (FSR) for India to enhance transparency and augment confidence in the financial system. The Financial Stability Report (FSR) published today is the first of these reports and is an attempt at institutionalising the implicit focus and making financial stability an integral driver of the policy framework.

In general, the Financial Stability Reports will focus on reviewing the nature, magnitude and implications of risks that have bearing on the macroeconomic environment, financial institutions, markets and infrastructure. It will also assess the resilience of the financial sector through stress tests. It is hoped that FSRs will emerge as one of the key instruments for directing pre-emptive policy responses to incipient risks in the financial system.

The FSR will be a key supplement to the evolving institutional arrangements in the coming months. The specific composition and the role of the proposed Financial Stability and Development Council (FSDC) is yet to crystallise. But the role of the Reserve Bank in any future arrangement, as regards financial stability, will continue to be critical. This inaugural report details the prevailing financial system in India and also gives some background on past financial stability initiatives.

Global Outlook
The forceful and coordinated global policy response to the crisis has facilitated the relative stabilisation of global markets and easing of credit risk concerns after the financial turmoil, especially in the second half of 2009. Uncertainties about growth prospects and financial stability, however, persist. The unevenness of the global recovery adds to this uncertainty. Further, concerns about sovereign credit risk have also intensified in the light of the fiscal woes of Greece and some other Euro zone nations.

While global imbalances declined somewhat due to contraction of demand in advanced economies during the financial crisis, the structural problem associated with the imbalances remains. There are some incipient signs of the recurrence of these imbalances with the economic recovery, which is reminiscent of the pre-crisis days and could emerge as a cause for concern. Though the exposure of the Indian financial system to the international markets remains relatively low, the contagion impact from the global macroeconomic shocks on the Indian financial sector cannot be ruled out.

Outlook for India
There are evident signs of recovery in the growth increasingly taking hold. Hence, the process of monetary policy exit has already begun. Early steps to exit from the fiscal stimulus measures have also been initiated with the Union Budget for 2010-11 committing a return to the process of fiscal consolidation. The process of fiscal consolidation should facilitate better monetary management. In recognition of the Government’s intent to bring down deficit and debt levels, along with the positive outlook on domestic economic growth, S&P has recently upgraded its outlook on India from “Negative” to “Stable”.

Going forward, however, there are several factors which may have a bearing on financial stability considerations, including inflationary pressures and expectations, management of government borrowing program, and capital flows.

To read the full report: FSR