Three economic risks in need of mitigation plans

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Three economic risks in need of mitigation plans

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• Central banks rewiring themselves: In recent years, many central banks of the world have restructured their thinking and approach to respond to various crises in their economies, most recent one being the Covid crisis. The standard approach is to keep interest rates low, infuse liquidity with no sunset clause, and continue on.
• Rising inflation: This liquidity push led to growth revival, and sudden realisation of poor capacity to meet new demand. Net result? Rising inflation. The US Fed changed its stance to indicate it might begin raising policy rates in 2023 itself (not later), so that may impact Indian economy too.
• RBI's FSR: In July, the RBI published the June 2021 Financial Stability Report (FSR), and spoke on these issues.

1. It accepts that a return to pre-pandemic activity level will take longer, due to patchy opening up of economy and fluctuating vaccination rates
2. Supply side has been hurt, and is taking its own time to rebuild
3. Demand side will improve based on new jobs created and households feeling confident to consume and not save

• Three clear risks to financial stability: India faces three risks, two from the outside world.

1. Cutting down in global capital flows
2. Commodity inflation
3. Domestic banking sector's troubles

• Mitigation: How to mitigate these risks? There's no plan so far, though various suggestions have come, including allowing RBI forex reserves to be used for infrastructure building. That may be a problem if a "taper tantrum" happens from the USA and capital inflows suddenly reverse.
• Interest rates: Imported inflation may push local inflation up steeply, as household expectations clearly indicate. RBI must now rethink its repo rate policy, because low rate has not really ensured capital expansion or economic growth, but helped already indebted wholesale borrowers.
• NPA worries: To ensure that banking sector does not crash, the extended regulatory forbearance will be the acid test. Stress testing by RBI (on NPAs and capital backing) may be giving wrongly positive signals. Capital is key to meeting any bad loan crisis as well as giving out fresh loans when things pick up. The provider of capital is the government, currently constrained badly.
• Summary: Let the government prepare for the future by creating fresh parcels of new equity in banks, and selling them to retail and institutional investors.

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