Stressing stability – Indian policymakers must remain vigilant

Source: The post is based on the article “Stressing stability – Indian policymakers must remain vigilant” published in The Hindu on 10th May 2023.

Syllabus: GS 3 – Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

Relevance: About Carbon Border Adjustment Mechanism of EU.

News: The Financial Stability and Development Council, headed by Union Finance Minister deliberated the need for having more early stress indicators to enable regulators to identify potential problems and deal with them in time.

What are the various macroeconomic risks that necessitated the need for early stress indicators?

a) There are several interrelated risks emanating from the global economy. The increased global economic and financial interdependence has increased risks. Though this interconnectedness has merits, emerging market countries like India should build safety margins to limit the downside risks.

b) Ongoing trouble in the US banking system: Three out of the four biggest bank failures in the US have happened over the past two months. A sharp increase in interest rates by the US Federal Reserve has led to large losses in the investment portfolio of banks. As a result, handling the pressure of deposit withdrawal is becoming difficult for some banks.

Though they may not pose an immediate threat to financial stability, policymakers would do well if they remain prepared.

c) Impact of the US banking system on Indian IT firms: The banking and financial services sector is a major source of revenue for Indian technology firms. So, their impact can directly affect the functioning of Indian IT firms.

d) High budget deficit in several advanced economies: The fiscal deficit is expected to average over 6% of gross domestic product (GDP) over the next decade. This will be significantly higher than the average of about 3.5% of GDP witnessed in recent decades and will have implications for the global financial markets.

e) US Fed and other central bank’s policies: A structurally higher deficit in the US would mean the Fed might maintain higher interest rates for a longer period. The higher demand for savings by the US and other governments in the developed world would limit the amount of funds flowing to emerging market countries.

f) Volatility in currency markets: Sustained higher budget deficits and higher interest rates could also increase volatility in currency markets.

Since India has no control over the things that unfold in advanced economies, it is required to identify early stress indicators.

Overall, from the Indian government’s side, the government should bring down the fiscal deficit at the earliest. This will help reduce dependence on foreign capital and improve macroeconomic stability.