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The Reserve Bank of India (RBI)'s Financial Stability Report (FSR) paints a picture of an Indian economy facing headwinds from a slowing global economy, even as its domestic financial system remains largely resilient and inflation appears to be on a path towards the central bank's target. The report highlights a concerning correlation: a slowdown in global growth is projected to negatively impact India's domestic output. Specifically, the FSR estimates that a 100 basis points (bps) deceleration in global growth could reduce India's growth by a substantial 30 bps. This underscores the interconnectedness of the global economy and India's vulnerability to external economic shocks. The report points to several factors contributing to this vulnerability, including protracted geopolitical tensions, heightened uncertainty surrounding international trade, and disruptions stemming from various global events. Furthermore, weather-related uncertainties add another layer of complexity to the growth outlook. Sanjay Malhotra, the Governor, emphasizes in the foreword to the FSR that these external spillovers and unpredictable weather events pose significant downside risks to India's economic growth trajectory. While the overall financial system is described as resilient, the FSR notes a slight increase in stress within financial markets, primarily attributed to these global spillovers. This is reflected in the marginal rise in the Financial System Stress Indicator (FSSI), which serves as a gauge of the stress level in the Indian financial system. The report indicates that this increase in stress is a recent phenomenon, observed when comparing the current situation to the first half of the 2024-25 fiscal year. This suggests that the impact of global uncertainties is beginning to be felt within the Indian financial system, requiring careful monitoring and proactive measures to mitigate potential risks. Despite these challenges, the FSR offers a relatively optimistic outlook for food inflation. It anticipates that the prices of food items will soften, driven by robust crop production. This positive development is crucial for managing overall inflation and ensuring food security for the country's large population. Moreover, the risk of imported inflation is deemed to be largely low, primarily due to the anticipated slowdown in global growth, which is expected to dampen commodity and crude oil prices. However, the report acknowledges that the recent escalation of geopolitical tensions in the Middle East introduces a significant element of uncertainty, potentially disrupting commodity markets and affecting import costs. The report also suggests a favorable trajectory for headline inflation. The RBI anticipates that headline inflation will durably align with its target of 4% in the near and medium term. In fact, the FSR even projects that inflation may undershoot the target marginally, indicating a significant degree of confidence in the central bank's ability to manage inflationary pressures. This positive outlook on inflation provides the RBI with greater flexibility in its monetary policy decisions, allowing it to focus on supporting economic growth without the immediate pressure of combating high inflation. The FSR highlights the resilience of India's external sector as a key contributing factor to the country's macroeconomic and financial stability. The current account deficit (CAD) is projected to remain manageable, at 0.6% of GDP during 2024-25. This is attributed to the sustained buoyancy in services exports and remittances, which help to offset the trade deficit. In fact, the current account balance even turned into a surplus of 1.3% of GDP during the January-March 2024-25 period, further strengthening the external sector's position. This strong external sector performance provides a buffer against external shocks and enhances India's overall economic resilience. The RBI's FSR provides a comprehensive assessment of the Indian economy, highlighting both the challenges and opportunities it faces. While the slowdown in global growth poses a significant threat to domestic output, the resilience of the financial system, the favorable outlook for inflation, and the strength of the external sector provide grounds for optimism. The report underscores the importance of proactive policymaking and effective risk management to navigate the complex global economic landscape and ensure sustainable and inclusive growth for India. The implications of a global slowdown reverberate throughout India's economic landscape, creating a ripple effect that touches various sectors and industries. The projected 30 bps reduction in India's growth for every 100 bps deceleration in global growth is not merely a statistical figure; it represents a tangible decrease in economic activity, potentially leading to reduced job creation, lower investment levels, and diminished consumer spending. This slowdown can particularly affect export-oriented industries that rely heavily on global demand. For example, sectors such as textiles, engineering goods, and pharmaceuticals could experience a decline in sales and profitability, impacting employment and investment in these areas. The impact of geopolitical tensions, trade disruptions, and weather-related uncertainties further compounds the challenges facing the Indian economy. These factors can lead to increased volatility in commodity prices, disruptions in supply chains, and reduced investor confidence, all of which can negatively affect economic growth. The rise in the Financial System Stress Indicator (FSSI) is a cause for concern, as it indicates that the Indian financial system is becoming more vulnerable to external shocks. This increased stress could manifest in various ways, such as higher borrowing costs for businesses and individuals, reduced availability of credit, and increased risk of defaults on loans. The RBI needs to closely monitor the FSSI and take proactive measures to address any emerging risks to financial stability. The favorable outlook for food inflation is a welcome development, as it can help to ease the burden on households and improve consumer sentiment. However, it is important to ensure that the benefits of lower food prices are passed on to consumers, particularly those in vulnerable sections of society. The government can play a role in ensuring that supply chains are efficient and that there are no artificial price increases due to hoarding or other market manipulations. The RBI's projection that headline inflation will durably align with its target of 4% is a positive sign for the Indian economy. This can help to stabilize interest rates, encourage investment, and boost consumer spending. However, the RBI needs to remain vigilant in its monitoring of inflation and be prepared to take action if inflationary pressures re-emerge. The strength of India's external sector is a key asset in the current global economic environment. The manageable current account deficit and the surplus in the current account balance during the January-March 2024-25 period provide a buffer against external shocks and enhance India's overall economic resilience. However, it is important to continue to promote exports and attract foreign investment to maintain a healthy external sector balance. The RBI's Financial Stability Report provides valuable insights into the current state of the Indian economy and the challenges and opportunities it faces. The report underscores the importance of proactive policymaking, effective risk management, and continued reforms to ensure sustainable and inclusive growth for India. The government and the RBI need to work together to address the challenges posed by the global slowdown, manage inflationary pressures, and strengthen the financial system. In addition to the specific issues highlighted in the FSR, there are several other factors that could affect India's economic growth in the coming years. These include the pace of structural reforms, the level of investment in infrastructure, and the quality of education and healthcare. Addressing these challenges will be crucial for ensuring that India can achieve its full economic potential. The report also serves as a reminder of the interconnectedness of the global economy and the importance of international cooperation. India needs to work with other countries to address global challenges such as climate change, trade disputes, and geopolitical tensions. By working together, countries can create a more stable and prosperous global economy for all. Furthermore, the RBI's report prompts a deeper exploration into the policy measures that can be implemented to mitigate the adverse effects of a global slowdown on India's domestic output. One area of focus should be on strengthening domestic demand to reduce reliance on external factors. This can be achieved through measures such as boosting infrastructure spending, promoting entrepreneurship, and increasing consumer spending. Infrastructure investment can create jobs and stimulate economic activity, while also improving the country's long-term competitiveness. Promoting entrepreneurship can foster innovation and create new businesses, which can contribute to economic growth and job creation. Increasing consumer spending can be achieved through measures such as tax cuts and income support programs, which can put more money in the hands of consumers and encourage them to spend. Another important policy area is to diversify India's export markets and reduce reliance on a few key trading partners. This can help to insulate the country from the effects of a slowdown in any particular region. The government can work with businesses to identify new export markets and provide support for them to enter these markets. In addition, the government can negotiate trade agreements with other countries to reduce trade barriers and promote exports. Strengthening the financial system is also crucial for mitigating the risks posed by a global slowdown. The RBI needs to continue to monitor the FSSI and take proactive measures to address any emerging risks to financial stability. This could include measures such as increasing capital requirements for banks, strengthening regulations for non-banking financial institutions, and improving the supervision of the financial system. In addition to these policy measures, it is also important to improve the country's competitiveness by investing in education, healthcare, and research and development. A well-educated and healthy workforce is essential for long-term economic growth. Investing in research and development can foster innovation and create new industries. By improving its competitiveness, India can attract foreign investment and increase its exports. The RBI's Financial Stability Report provides a valuable framework for policymakers to address the challenges and opportunities facing the Indian economy. By implementing appropriate policies, India can mitigate the risks posed by the global slowdown and achieve its full economic potential. The proactive measures the RBI and the government take now will determine the trajectory of India's economic future in an increasingly uncertain world. The ability to adapt, innovate, and strengthen domestic resilience will be key to weathering global storms and achieving sustainable and inclusive growth.
Source: Slowdown in global growth to hurt India's domestic outputs: RBI report