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It examines the country's financial stability

The Reserve Bank of India (RBI) published its latest Financial Stability Report last week (FSR). As the name implies, it examines the country's financial stability, and it is compiled with input from all financial sector regulators. In other words, it provides information on the present state of various financial organisations, such as banks and non-banking lending firms. It also depicts the level of credit expansion and the rate at which borrowers fail to repay their debts.

The RBI also conducts a Systemic Risk Survey (SRS) as part of the FSR, which is released twice a year, in which it asks experts and market participants to assess the financial system on five main categories of risks: global, financial, macroeconomic, institutional, and general.


The FSR reveals how resilient or susceptible our financial system — particularly our banking sector — is to economic shocks. It also informs us if and to what degree our banks and other lending institutions (such as Non-Banking Finance Companies and Housing Finance Companies) will be able to sustain future development.

For example, if the FSR shows that the banking system's percentage of non-performing assets (NPAs or bad loans) is high, and the government's fiscal deficit is also high, it means that not only will banks struggle to function effectively (and fund future growth), but that if banks fail, the government may find it difficult to bail them out.

The following are some of the most important insights and charts from the most recent FSR. The default comparison is to the previous FSR, as this is a biennial release.


The world's economic growth has slowed

"Since the July 2021 issue of the FSR, the rejuvenation of the global recovery in the first half of 2021 has begun to lose momentum, impacted by the resurgence of infections in several parts of the world, supply disruptions and bottlenecks, and the persistent inflationary pressures that have manifested themselves in their wake," the latest FSR states.

"Even nations with relatively high immunisation rates, which appeared to be emerging as global growth drivers, are seeing a halt in activity."


The FSR identifies a few critical variables that reflect this blunder

Chart identifies a few critical variables that reflect this blunder. The rejuvenation of the global recovery in the first half of 2021 has begun to lose momentum.Indian express/wikipedia

For example, the World Trade Organization's (WTO) Goods Trade Barometer (see CHART 1) shows that global merchandise trade volumes, which rose 22.4 percent year over year in Q2 (April to June) of the 2021 calendar year, have slowed in the second half of the year. According to the FSR, "the decrease in the barometer reflects a mix of declining import demand and interrupted production and supply of frequently traded products like as autos and semiconductors."

The Baltic Dry Statistic, which is a gauge of shipping expenses for dry bulk goods, is another important index. In October 2021, this indicator reached its greatest level in almost a decade, but it then dropped sharply.

Also read: India Faces Technical Recession: RBI

Similarly, throughout July, August, and September, the Global Economic Surprise Index (GESI), which compares incoming data with experts' projections to capture the surprise factor (see CHART 3), fell into negative territory as actual growth data differed from earlier forecasts (Q3:2021).

The development of the Omicron variant has further added to the confusion. All of this has a significant impact on emerging nations (such as India), where vaccination rates are much lower than in established economies and where central banks in wealthy countries are likely to make money more expensive (by raising interest rates).


There is a disconnect between India's real economy and its stock markets

"Lifted by the global bull market in equities markets, the Indian equity market rose on robust rallies with periodic corrections," according to the FSR. "Strong investor interest has significantly pushed up price-earnings (P/E) ratios. "The price-to-book value (P/B) ratio, the market capitalization-to-GDP ratio, and the cyclically adjusted P/E ratio, or Shiller P/E, are all above their historical norms.

The RBI study states, "This shows some mismatch between the real economy and equities markets." This isn't the first time the RBI has expressed concern about the widening gap between the condition of the economy and the rate at which India's stock markets have expanded. Divergence at high levels is a problem.


FSR Chart Chart shows the credit growth rate.Indian express/wikipedia


The improvement in the credit growth rate is very significant. In CHART 5, the blue line is starting to rise and form a "U-shaped" recovery. However, there are still certain areas of worry amid this general progress.

For the first time, the growth rate is still much below the optimal level. Second, while retail credit (less Rs 5 crore) is rising at a healthy rate, wholesale credit (above Rs 5 crore) continues to suffer. Furthermore, data reveals that public sector entities are absorbing the majority of wholesale credit, while the private sector is deferring new funding.


By September 2022, NPAs may have risen

The condition of bank nonperforming assets (NPAs) is a critical variable to keep an eye on in any FSR. Each FSR, in particular, undertakes "stress testing" to see what would happen to the NPA level if something goes wrong. These stress tests simulate "hypothetical unfavourable economic conditions" by varying factors such as GDP growth, combined fiscal deficit-to-GDP ratio, CPI inflation, weighted average lending rate, exports-to-GDP ratio, and current account balance-to-GDP ratio progressively worse.

According to the latest FSR, the NPA of India's Scheduled Commercial Banks (SCBs) will be 6.9% at the end of September 2021. According to the FSR, "stress assessments suggest that the Gross NPA ratio of all SCBs might climb to 8.1 percent by September 2022 under the baseline scenario and to 9.5 percent under severe stress." Typically, public sector banks are the most prone to such blunders among all banks. That holds true this time as well. "Under the baseline scenario, public sector banks' GNPA ratio of 8.8% in September 2021 may worsen to 10.5 percent by September 2022," according to FSR.


(keywords: RBI, Credit Growth, NPA, FSR, GDP, U-shaped" recovery)


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