The current weak global growth outlook may prolong easy monetary policy stance in most advanced economies
(AEs). Consequently, low risk premia may lead to accumulation of vulnerabilities and sudden and sharp overshooting
in markets cannot be ruled out. As of now, financial risk taking has not translated into commensurate economic
risk taking. Against the backdrop of low interest rates in AEs, portfolio flows to emerging market and developing
economies (EMDEs) have been robust, increasing the risk of reversals on possible adverse growth or financial market
shocks, thus necessitating greater alertness.
On the domestic front, macroeconomic vulnerabilities have abated significantly in recent months on the back of
improvement in growth outlook, fall in inflation, recovery in the external sector and political stability. However,
growth in the banking business and activity in primary capital markets remain subdued due to moderate investment
intentions. Sustaining the turnaround in business sentiment remains contingent on outcomes on the ground.
Global backdrop
1.1. Global recovery seems to have weakened.
While economic growth is finding traction in the US,
it appears to be slipping in the Euro area and seems
to be reversing in Japan. Any hard landing in China
is an additional risk to global growth. Further,
geopolitical risks emanating from developments in
the Middle East and Ukraine are also impacting the
global economy. Without a change in the pattern of
growth and stability that still leans heavily on easy
money, vulnerabilities remain, especially with
inflation ruling below policy targets in many
jurisdictions and the threat of deflation continuing
in others.
1.2. Against this backdrop, the prospects for global
financial stability remain uncertain amidst an
ambience wherein weak growth prospects are still
considered benign for financial markets in the
expectation that ultra-easy monetary policies will
continue. Stock markets around the world, particularly
in advanced economies (AEs) have been buoyant with
lower volatility until recently, a situation earlier
experienced in the period of financial excesses leading
to the global financial crisis (Chart 1.1). Despite the
end of quantitative easing (QE) in the US, carry trades
are likely to continue with both the Bank of Japan (BOJ) and the European Central Bank (ECB) adding to
global liquidity. Simultaneously, low yields are
impacting pension and retirement funds prompting
them to shift their investment strategies towards
riskier options. Amidst this sense of relative serenity,
the October 15 flash crash in US Treasury bond yields
may be a harbinger of the risks that may unfold.
 Domestic macroeconomic conditions
Growth
1.3. Domestic activity weakened in Q2 of 2014-15
with growth at 5.3 per cent. Activity is likely to be
muted in Q3 also because of a moderate kharif harvest.
Choppiness in the index of industrial production (IIP)
growth during 2014-15, so far, has raised questions
over consolidation of industrial growth. With capacity
utilisation1 during Q1 2014-15 being the lowest in the
last four years (Chart 1.2), significant new investments
may take time to materialise. In addition, measures
of new investment intentions currently show only a
modest pickup in investments (Chart 1.3). The
Reserve Bank’s current central estimate for GDP for
2014-15 is placed at 5.5 per cent with a gradual pickup
in momentum through 2015-16.
Inflation
1.4. High and persistent inflation often gets
entrenched into inflation expectations and leads to
uncertainty over prices. As a result, high inflation can
adversely impact investment and consumption
decisions. Against this backdrop, the substantial
easing in CPI inflation to 4.4 per cent in November
2014 from 11.2 per cent a year earlier (Chart 1.4) marks
a significant improvement in the Indian macroeconomic
environment. The Reserve Bank’s latest projections
suggest that CPI inflation over the next 12 months
may hover around 6 per cent if the international crude
prices remain around the current levels and the
monsoon next year turns out to be normal.
Credit
1.5. Growth in bank credit and deposits has been
relatively low in the recent past (Chart 1.5). Slowdown
in credit growth has been broad-based barring
agriculture and allied activities (Chart 1.6). Low credit
growth reflects a combination of factors such as
reliance on alternative sources of funding, balance
sheet repair and slack in demand as also an element
of risk aversion. However, pickup in credit assumes
importance in the present context given that credit
cycles have been leading business cycles in the post-reform
period2 (Chart 1.7). Banks, therefore, need to
prepare themselves to meet credit demand as
investment picks up.
Household financial savings
1.6. The gross domestic saving rate declined to
30.1 per cent in 2012-13, the lowest in the past nine
years. This reduction is explained to a large extent by
a fall in households’ financial saving rate (Chart 1.8)
amid their shifting preferences towards physical
assets and valuables. However, preliminary estimates
of the household financial saving rate for 2013-14
show a marginal increase, largely with respect to bank
deposits and small savings. Revival in investment
activity needs to be supported by an increase in
financial savings.
External developments
1.7. With the containment of the current account
deficit (CAD), improvement in capital inflows, relative
stability of the exchange rate and accretion to the
foreign exchange reserves, external vulnerability has
reduced (Chart 1.9). While fall in global crude oil and
commodity prices will help containing CAD,
continuous vigil is warranted as capital inflows tend
to be volatile.
1.8. Foreign portfolio investments (FPIs) into India
were robust during 2014 (Charts 1.10a and b).Their
heightened interest in debt may create volatility in
domestic debt markets despite some evidence that
FPIs are taking a longer term view on the Indian debt
paper. Given the primacy of US based FPIs in India
(Charts 1.11a and b), unexpected changes in the US monetary policy could have adverse effects on FPI
flows through direct and indirect channels.
Financial markets
1.9. Portfolio inflows into emerging market
economies (EMEs) during 2014 were robust (Chart
1.12). Indian stocks and the rupee outperformed their
counterparts in other EMEs (Charts 1.13 a and b).
Though Indian stocks rose sharply after May 2014,
they seem to be only catching up with the likes of
MSCI AE and S&P 500 which started their upward
movement much earlier. Improvement in overall
macroeconomic conditions, a relatively stable
exchange rate, return of political stability and
expectations of growth enhancing reforms seem to
have created a relative advantage in favour of India
and unleashed the pent up demand for Indian assets.
The challenge ahead is to reinforce expectations
through commensurate structural reforms.
Government expenditure
1.10. The Union Budget 2014-15 aimed at achieving
higher growth along with macroeconomic stability
through lower inflation, reduction in fiscal deficit and
a manageable current account deficit. Available
information for the first seven months of the current
financial year indicates that total expenditure as
percentage of budget estimates (BE) was lower
compared to the corresponding period in the previous year, primarily on account of lower plan and non-plan
revenue expenditure (Chart 1.14). Expenditure on
major subsidies was significantly lower at 70.8 per
cent of BE during first seven months of the current
financial year (78.4 per cent a year ago). Overall capital
expenditure was lower by 1.1 percentage points due
to lower non-plan capital expenditure.
1.11. However, tax revenue as a percentage of BE
was lower during April-October 2014-15 as compared
to the previous year reflecting lower collections under
all major taxes. Non-tax revenue as per cent of BE was
also lower (Chart 1.15). The lower revenue mobilisation
which is partly emanating from still subdued
economic activity is a major concern.
Mortgage debt: House prices and loan to value/
income ratios
1.12. House prices witnessed correction in many
cities during Q1 2014-15.3 Further, the proportion of
loans at high loan to value ratio (LTV) has been falling
(Chart 1.16) and lending for housing at high loan to
income ratio (LTI) is also relatively low4 (Chart 1.17).
However, a reversal in directional movement in LTV
and LTI has been observed in Q1 2014-15.
1.13. Development of housing and mortgage
markets has an important role in growth and
employment. Given that the government is committed
to a policy of housing for all by 2022, the housing
sector has immense potential to grow; so do the
mortgage markets. In this context, the Securities and Exchange Board of India (SEBI) recently notified the
SEBI (Real Estate Investment Trusts) Regulations, 2014
(Box 1.1). These regulations are expected to aid the
development of the real estate sector in India with
benefits accruing to all stakeholders.
Box 1.1: Real Estate Investment Trusts
Globally, units of Real Estate Investment Trusts (REITs)
sell like stocks on major exchanges and they invest in real
estate directly, either in properties or mortgages. They
enjoy special tax considerations and typically offer
investors high yields as well as a framework for wider
investor participation in real estate. Most of the REIT
earnings are distributed to shareholders regularly as
dividends. According to the European Public Real Estate
Association’s (EPRA) Global REIT Survey 2014, 37
countries worldwide have REITs or ‘REIT-like’ legislations
in place. The structure of REITs varies across countries
and it is constantly evolving.5 Since their introduction in
Asia in the early 2000s, REITs have been adopted across
the continent, growing into a market worth over USD 140
billion.6
REITs are mainly of three types: Equity REITs, Mortgage
REITs and Hybrid REITs. Equity REITs invest in and own
properties and their revenues come principally from rents.
Mortgage REITs invest in real estate and mortgage backed
securities and their revenues are generated primarily as
interest income that they earn on the mortgage loans.
Hybrid REITs combine the investment strategies of Equity
REITs and Mortgage REITs by investing in both properties
and mortgages. Like any other investment, investments
in REITs have their own set of risks. Mortgage REITs
(mREITs) are involved in lending money to owners of real
estate and buying (mostly agency backed) mortgage
backed securities (MBS) and their business model layers
on other risks that could amplify market dislocations.
Some of these are: a) Funding and liquidity risk,
b) Refinancing and rollover risk, c) Maturity mismatch
risk, d) Convexity risk, e) Concentration and correlation
risk and f) Market risk. These risks, in turn, are interrelated
and their presence can lead to a fire sale event.
However, in India, the current REIT regulations do not
provide for mREITs and are aimed at developing the real
estate sector in a robust manner.
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