Episodes of severe financial market turmoil in India have often had their origins in global events. Therefore, it is not surprising that the latest Financial Stability Report (FSR) of the Reserve Bank of India should contain dire warnings on the global shocks that are interacting with each other to create ‘harsh challenges’ for EMs (emerging markets). Aggressive monetary tightening, the report says, has already led to an implosion in risky assets such as cryptocurrencies and could trigger runs on non-dollar currencies and EM bonds. With global central banks in the midst of their fastest and most synchronised rate hikes in 50 years, it expects indebted EMs and leveraged institutions to experience debt servicing difficulties. Global economies will need to deal with these risks in a weakened state too, with a likely slowdown in both GDP and trade in 2023. But as the report moves from discussing global generalities to specifics for India, it takes a rather sanguine view based on current metrics, without offering much forward-looking commentary on the risks that may yet unfold.

Based on recent data, the FSR argues that despite global shocks, the Indian economy has so far presented a ‘picture of resilience’, with its financial markets functioning smoothly. India’s commercial banks and NBFCs, helped by high capital buffers and multi-year low GNPAs (gross non-performing assets), have certainly handled global spill-overs well so far. Government finances are on a consolidation path and India Inc is sitting on low leverage, making them less vulnerable to fallouts of global tightening. Though India’s CAD (Current Account Deficit) has widened from 1.2 per cent in Q1FY23 to 4.4 per cent in Q2, the FSR takes comfort from buoyant services exports and remittances and says that CAD is being ‘comfortably financed’ by FDI and FPI inflows. Running its usual battery of stress tests, it theorises that even in a severe stress scenario, no Indian bank would fall short of minimum capital requirements, unlike in the last cycle.

While all this is reassuring, one hopes the RBI recognises that any or all of the above variables can go downhill very quickly. The presently high capital buffers and low GNPAs of banks are a function of very restricted lending during the pandemic. The real test will lie in the months ahead as credit demand picks up and transmission of the MPC’s 225 basis point rate hike in 2022 is passed through. On CAD financing, FDI flows have already been dented by shrinking PE/VC investments in recent months, while FPI flows are at best a fair-weather friend. It must be recalled that the FSR’s stress tests failed to foresee the sharp escalation in domestic NPAs between FY14 and FY18, after the taper tantrum. It is good to see recent editions of FSR move away from an overly pessimistic tone, to take a more fact-based view of the financial system. But one hopes that India’s regulators are still keeping a hawk eye on global events and bracing for the possibility that the brewing global storm could yet land on Indian shores.