Reserve Bank of India (RBI) governor D Subbarao has said that India may escape the worst consequences of the global financial crisis but warned of indirect impacts on capital flows, exports and higher demand for loans in the domestic market.
While he drew comfort from the limited exposure of Indian banks to the US mortgage market and failed and stressed financial institutions, Subbarao said that the foreign exchange and the equity markets provide channels through with the crisis can spread into the Indian system. In addition, the governor said, there may be an indirect effect on the money, debt and credit markets, which is not trivial, and added that this can intensify in the months ahead.
“Risk aversion, deleveraging and frozen money markets have not only raised the cost of funds for Indian corporates but also its availability in the international markets. This will mean additional demand for domestic bank credit in the near term. Reduced investor interest in emerging economies could impact capital flows significantly. The impending recession will also impact on Indian exports,” Subbarao said at the meeting of the International Monetary Fund in Washington on Saturday. The governor’s speech was made public today.
He added that the coordinated steps being taken by the developed countries should factor in the effect on emerging and developing economies, which should be consulted whenever the policies and actions have implications for them.
Subbarao, who is the leader of the Indian delegation at the IMF’s International Monetary and Financial Committee Meeting, said that the collapse of investment banks in the US over the last two months has resulted in a breakdown of trust in inter-institutional lending and the full resolution of the crisis will take time.
While acknowledging that the crisis is unprecedented, the RBI governor said there is a need for regulation to stay ahead of the curve. “However, there is need for a note of caution here. There is a distinct risk that in trying to stay ahead of innovation, regulation may get so stringent that it stifles innovation.”
While supporting free competition Subbarao said, “The right lesson to draw is that markets and institutions do succumb occasionally to excesses, which is why regulators have to be vigilant, constantly finding the right balance between attenuating risk-taking and inhibiting growth.”
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In addition, he suggested better coordination among authorities and revisiting the roles of central banks, regulators, supervisors, and fiscal authorities regarding financial stability.
Further, he said that the bailout packages announced in recent weeks will have an impact on the regulatory architecture of the financial system and on the fiscal position of countries. Subbarao also suggested that there is a need to look at the deposit insurance coverage and whether the scope should be extended to money markets and mutual funds.
Pointing to the crisis revealing the weaknesses of structured products and derivatives in the credit markets, Subbarao said there were questions related to exchange traded derivatives being superior to their over-the-counter (OTC) counterparts and also mentioned the need to debate if appropriate clearing and settlement practices even for OTC products should be prescribed.