The Indian financial sector remains stress-free notwithstanding intermittent volatility ? especially in equity and foreign exchange markets ? driven primarily by exogenous developments, the Reserve Bank of India (RBI) said. In its second financial stability report (FSR), the central bank, however, cautioned, that some soft spots were discernible.
?The current account deficit is widening while capital flows continue to be dominated by volatile components,? the RBI pointed out, adding ?external sector ratios have deteriorated, fiscal conditions are still under pressure and inflationary pressures persist.? The RBI believes that with both financial and real sectors still under stress in advanced economies, the country will have to guard against vulnerabilities arising from risks to global growth and financial stability.
The tail risks to financial stability, RBI believes, are largely exogenous given increasing correlation between global growth and growth of emerging market economies (EMEs) including India. ?Convergence with the emergent international reforms agenda presents challenges and will require careful calibration. The finance channel has assumed greater importance increasing the pace and degree of contagion from disturbances abroad. Similarly, business cycle synchronisation of the Indian economy with most of the advanced economies and other EMEs has increased,? RBI observed.
The RBI feels the asset quality of banks and their ALM position continue to warrant monitoring. The RBI said emerging developments in the telecom and real estate sectors may impact lending to and asset quality of these sectors. ?The developments may still have adverse repercussions in the form of overly cautious lending to both the sectors,? it noted, adding that non-performing assets (NPAs) for the real estate sector had seen an increase of 8% during the quarter ended September 2010.
The RBI feels liquidity conditions have tightened beyond its comfort level, though some policy measures have recently been taken to alleviate the stress. The RBI noted that the share of core deposits to total assets has progressively declined over the years, except in the quarter ended March 2010 and September 2010. Despite a high ratio of temporary assets to total assets, the coverage of liquid assets in relation to volatile liabilities has remained less than one, indicating potential liquidity strains. Nevertheless, growth, it said, had rebounded strongly while financial conditions remained stable since the publication of the first FSR, in March 2010. Financial institutions, the RBI said, remained healthy and credit offtake had picked up as had profitability, especially in the first half of 2010-11.
