India (RBI) in one way or another and the RBI can print money to enable the government to redeem its bonds. However, this only takes us to another form of systemic risk – inflation. The reason is simple. Excess monetary expansion in such a situation can be inflationary. There is no free lunch. Third, current account deficit is an important concern though the situation has improved somewhat. Rupee has depreciated considerably in the last one or two years. This should hopefully start showing its positive effects on external balance in the near future. So the deficit problem on the current account is not as serious now as it was one year ago. On the other hand, the capital account too seems to be showing signs of improvement. Capital flows had slowed down for some time but the worst on this front seems over though we always need to be on the lookout. This is particularly true given the ratio of reserves to GDP, which is not as comfortable as it was some years ago. Our capital controls are leaky and a formal international credit line from the IMF is absent. So we need to take a lot of care. Fourth, consider asset markets. Let us begin with the stock market. It is very difficult to predict this market. So let us make a relatively safe comment. The Indian stock market is not ‘grossly overvalued’ or ‘grossly undervalued’ at present, given the current information. By this account, the stock market prices in India are ‘stable’ from the viewpoint of systemic risk. There are also hardly any reports of high leverage in the economy. There is, however, a systemic operational risk that does still bother in India. There cannot be room for complacence here. The derivatives market has grown very fast in India in recent years but the market size is still small. So there cannot be much of a systemic concern here at this point of time. Real estate prices are quite high in some parts of India relative to (a) ‘fundamentals’, (b) prices in other parts of India, (c)
prices in many parts of the world. We have still not learnt lessons from the sub-prime crisis in the US. Some people invest heavily in real estate and have inadequately diversified portfolios. This is not safe. So there can be a big risk for households and for the economy as a whole if real estate prices were to fall. Gold is, in normal times, hardly ever a cause of concern, given the nature of the asset. However, there has been a large investment (speculative?) demand for gold in recent years. So there is need for care though some hedge funds in the West take a different view. In another and very different sense in the long run context, gold is always a cause of concern. The intrinsic value of gold is low and the market price is high. So, we have a bubble of sorts (though there can be a debate about the meaning of intrinsic value).
Fifth, inflation has been high for several years now in India. There is, however, hardly any danger of inflation getting any worse in the sense of endangering systemic risk. This is not to say that there is no need to bring down the inflation rate. Less well known fragility Ask people about Indian banks and they say we are safe. Ask why? Then they say that banks are government backed. So far this is good. But then ask another question. What is the fiscal condition of the government?
February 2013
6