As the government and the Reserve Bank have started withdrawing economic stimulus measures, the central bank today said the process of exiting from these steps will test the flexibility of the entire financial system of the country.
"The process of exiting from an accommodative fiscal and monetary stance will be a test of the resilience of the entire system," the Reserve Bank said in its first-ever report on financial stability. One of such challenges will be managing the abundance of capital inflows, the report noted.
"Interest rate and growth rate differential between India and the developed markets has the potential to cause large capital flows into the country," the report said, adding capital flows have, in fact, already increased with rise in risk appetite in view of the early economic recovery in the country, sharp improvement in asset prices and early exit from the extraordinarily accommodative monetary and fiscal policies compared to other developed and even some emerging markets.
"Large capital flows beyond the absorptive capacity of the economy exert pressure on the exchange rate and have implications for financial stability," the apex bank said.
The report further said the visible improvement in the global economic outlook in the recent times has led to a worldwide debate on the timing and sequencing of exit from the expansionary monetary and fiscal stance. The exit strategy, however, should be debated in the context that the domestic economy is qualitatively different from advanced countries, the RBI said.Report
Citing an example, the report pointed out that while most of the advanced countries do not face immediate risk of inflation, India is confronted with an upturn in headline inflation. Also, India is traditionally a supply-constrained economy in contrast to advanced economies which are demand starved.
While many developed countries are on a fragile and slow recovery, India is estimated to grow 7.2 per cent this fiscal and the government expects the growth to gather further momentum at 8.5 per cent next fiscal and 9 per cent a year after that.