Disconnect between financial markets & real economy poses risk to financial sector : 12-01-2021

Reserve Bank of India Governor Shaktikanta Das has once again reiterated the growing disconnect between financial markets and the real economy. Das said that this growing disconnect poses a risk to the stability of the financial sector.

“The disconnect between certain segments of financial markets and the real economy has been accentuating in recent times, both globally and in India,” Das wrote in the foreword to the financial stability report. “Stretched valuations of financial assets pose risks to financial stability. Banks and financial intermediaries need to be cognisant of these risks and spillovers in an interconnected financial system.”

To be sure this is not the first time the RBI has flagged this off as a risk. In August last year Das had hinted that there could be an imminent correction in the buoyant stock markets.

The regulator in its financial stability report also said that while the active intervention by central banks and fiscal authorities has been able to stabilise financial markets, there were potential spillover risks due to this disconnect between certain segments of financial markets and real sector activity.

“In a period of continued uncertainty, this has implications for the banking sector as its balance sheet is linked with corporate and household sector vulnerabilities,” the RBI said.

Abundant liquidity across the globe has led to investors reaching for higher returns, growing the disconnect between financial markets and real sector activity, it said.

“Within the financial markets spectrum too, the divergence in expectations in the equity market and in the debt market has grown, both globally and in India,” the regulator noted.

The RBI which has taken several support measures due to the onslaught of the pandemic has warned about unwinding of these measures and the resultant impact this could have on the markets.

“The support measures may have unintended consequences as reflected, for instance, in the soaring equity valuations disconnected from economic performance,” the RBI said. “These deviations from fundamentals, if they persist, pose risks to financial stability, especially if recovery is delayed.”

Source : Financial Express