FSDC sub-committee warns India on risks associated with Greek crisis, US Fed rate hike

The Financial Stability and Development Council (FSDC) sub-committee report released on Thursday has warned India on the possible risks associated with the Greek debt crisis and the uncertainties lingering over the timing of rate increases by the US Federal Reserve.

"Going ahead there are two immediate possible concerns for financial market volatility and stability. First, failure to arrive at a workable solution for the Greek debt crisis, though at this juncture, bond markets in Europe appear to be sanguine to this. Second, uncertainty over the timing of rate increase by the US Federal Reserve," said the FSDC sub-committee report, published by the Reserve Bank of India (RBI).

According to the report, these triggers could lead to rapid decompression of term and risk premia leading to financial market volatility and losses, especially since market making activities/market liquidity is getting concentrated around the most liquid instruments while falling in the relatively less liquid securities.

"Emerging market and developing economies including India, therefore need to be prepared for the risks of greater volatility in financial markets and reversal of capital flows," said the report.

On Wednesday, RBI Governor Raghuram Rajan had said in Stockholm that the Indian economy would see through any impact of the Greece crisis. According to Rajan, one factor helping India was its stronger foreign exchange reserves.

The report has also highlighted the fact that in an increasingly integrated world, the uncertainties associated with continuation/withdrawal of large-scale stimulus by the world's three biggest central banks have increased challenges for global financial markets and consequently for emerging market and developing economies.

On Thursday, Assocham Secretary General D S Rawat said the markets would stay in a state of flux and the rupee might lose ground if the situation in Greece worsened. Greece is currently facing a payment crisis, and is scheduled to repay debt of $1.8 billion to the International Monetary Fund (IMF) on June 30. But it is believed the country does not have the money to pay.

On Thursday the rupee ended weaker at 63.63 against the dollar, compared with its previous close of 63.60 a dollar.

Last year there was significant increase in investments by foreign portfolio investors (FPIs) in government securities and corporate bonds and this had certainly helped in the appreciation of the rupee. FPIs based in the US account for a large share of assets under custody by all FPIs. The FSDC sub-committee report has warned that the search for yield inflows might be affected when the US Fed starts hiking interest rates amid possible volatility in global financial markets and safe haven flows, though India seems to be better prepared to deal with volatility now than it was in the past..