The growing disconnect between certain segment of financial markets and real sector has widened further since the publication of last financial stability report (FSR), the Reserve Bank of India (RBI) said on January 11.
“The growing disconnect between certain segments of financial markets and real sector activity, pointed out in the last FSR, has got further accentuated during the interregnum, with abundant liquidity spurring a reach for returns,” the latest FSR report said.
Within the financial market spectrum too, the divergence in expectations in the equity market and in the debt market has grown, both globally and in India, the FSR report said.
The functioning of financial markets in the recent months has been characterised by the economic impact of the COVID-19 pandemic, with financial institutions largely cushioned by abundant liquidity in the banking system, lowering of the cost of funds, and regulatory forbearance in asset classification of specified loans, the report said.
This observation is significant given that equity markets have been on a bullish tone in the recent past despite the economic growth contracting in the wake of the COVID-19 pandemic. Experts have cautioned investors on the growing disconnect between the real economy and financial markets. In other words, there is no underlying strength for the current bullish trend in stock markets, they have argued.
Although there has been rapid recovery in economic activity from the lows of March and April, major non-financial indicators remain below pre-pandemic levels, the RBI report said.
Stress may surface with a lag
More importantly, the RBI report has cautioned that the stress in the banking system, which is hidden for now due to the regulatory measures such as loan moratorium may surface eventually.
“Domestically, corporate funding has been cushioned by policy measures and the loan moratorium announced in the face of the pandemic, but stresses would be visible with a lag,” the RBI said.
Banks need to prepare for these adversities by augmenting their capital bases to support their own business plans and the broader economic recovery process in the post-COVID period, the RBI report said.
“Moreover, while easy financial conditions are intended to support growth prospects they can have unintended consequences in terms of encouraging leverage, inflating asset prices and fuelling threats to financial stability,” it said.
Credit growth (y-o-y) of SCBs, which had declined to 5.7 per cent by March 2020, slid further to 5 per cent by September 2020, the RBI report said.
For public sector banks (PSBs), credit growth picked up from 3 per cent in March 2020 to 4.6 per cent in September 2020, while for private sector banks (PVBs) it eased to 7.1 per cent from 10.4 per cent in March 2020, the report said.