Economy

indian economy: Disconnect between real economy and financial markets only getting worse

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Mumbai: The banking stability indicator has improved on all five parameters but as investors chase returns in the low interest-rate scenario, the disconnect between the real economy and the financial markets is getting worse, the central bank said in its Financial Stability Report (FSR) Monday.

Governor Shaktikanta Das wrote in the foreword to the FSR that the growing disconnect poses a risk to the stability of the financial sector.

“The disconnect between certain segments of financial markets and the real economy has been accentuating in recent times, both globally and in India,” Das wrote in the foreword.

“Stretched valuations of financial assets pose risks to financial stability. Banks and financial intermediaries need to be cognisant of these risks and spillovers in an interconnected financial system.”

To be sure, this is not the first time the Reserve Bank of India (RBI) has flagged this off as a risk. In August last year, Das had hinted that there could be an imminent correction in the buoyant stock markets.

The regulator also said that while the active intervention by central banks and fiscal authorities has been able to stabilise financial markets, there were potential spillover risks due to this disconnect between certain segments of financial markets and real sector activity.

“In a period of continued uncertainty, this has implications for the banking sector as its balance sheet is linked with corporate and household sector vulnerabilities,” the RBI said.

Abundant liquidity across the globe has led to investors reaching for higher returns, stretching the disconnect between financial markets and real sector activity, it said.

“Within the financial markets spectrum too, the divergence in expectations in the equity market and in the debt market has grown, both globally and in India,” the regulator noted.

The RBI, which has taken several support measures due to the onslaught of the pandemic, has warned about the unwinding of these measures and the resultant impact this could have on the markets.

“The support measures may have unintended consequences as reflected, for instance, in the soaring equity valuations disconnected from economic performance,” the RBI said. “These deviations from fundamentals, if they persist, pose risks to financial stability, especially if recovery is delayed.”

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