The International Monetary Fund (IMF) issued its latest Global Financial Stability Report, warning of the threats to the global financial system.
What are the IMF’s concerns regarding inflation?
- Premature Investor Enthusiasm: The IMF believes that investors may be unduly excited about the end of high inflation and the consequent interest rate cuts by central banks. This exuberance may be premature.
- The IMF notes that inflation may have halted in certain key advanced and emerging economies. Core inflation has been higher in the last three months than in the prior three, indicating that the rate of inflation fall may be slowing.
- Geopolitical Risks: The IMF cautions that protracted conflicts in West Asia and Ukraine might impair aggregate supply and drive up prices. This might undermine attempts to reduce inflation and discourage central banks from cutting interest rates.
- Potential Impact on Central Bank Action: According to the IMF, if these risks remain, central banks may delay or refrain from decreasing interest rates as markets expect, thereby affecting asset prices and investor losses.
How would it affect the Indian market?
- Strong Fund Flows: Emerging countries such as India have seen a surge in foreign capital inflows, fueled by expectations of central bank interest rate reduction.
- Vulnerability: If Western central banks indicate a lengthy period of high interest rates, investors may remove cash from emerging nations such as India, putting pressure on their currencies.
- The Indian rupee has already depreciated, reaching a new low versus the US currency. This tendency may persist if capital outflows intensify.
- In reaction to currency devaluation and capital outflows, the RBI may intervene by tightening liquidity and hiking rates. However, this may slow the economy.
- Potential Effects on the Financial System: A significant outflow of money might have ramifications for India’s financial system, increasing the rupee’s devaluation and creating instability.
Private Credit Market Scenario:
- The private lending market reached $2.1 trillion last year, highlighting its substantial impact on the financial environment.
- The IMF is worried about the unregulated private credit sector, which involves non-bank financial firms lending to business borrowers. Troubles in this sector might have far-reaching consequences for the financial system.
- India has also seen the expansion of a tiny private lending market, notably with the advent of Alternative Investment Funds (AIFs).
Conclusion:
The IMF’s concerns over premature investor optimism on inflation, as well as risks from geopolitical tensions, underscore potential vulnerabilities to Indian financial stability. Capital flows must be monitored and the private credit sector regulated.
Source: https://www.bloomberg.com/news/articles/2024-04-16/imf-lifts-growth-forecast-for-global-economy-but-warns-of-risks#:~:text=Global%20economic%20activity%20will%20expand,and%20next%20year%20at%203.1%25.