A disconnection between Certain Segments of Financial Markets & Real Sector Activity

A disconnection between Certain Segments of Financial Markets & Real Sector Activity

By: Ashwathy Nair

• The increasing disconnect poses a threat to the stability of the financial sector.
• Stretched estimations of financial assets pose threats to financial stability.
• The support measures might have unintentional consequences.

The banking stability indicator has upgraded on all five parameters but with investor chase returns in the low interest-rate scenario, the disconnection among the real economy as well as the financial markets is getting worse, it was stated by the central bank in its (FSR) Financial Stability Report.

In the foreword to the FSR, it was written by Governor Shaktikanta Das that the rising disconnect poses a threat to the stability of the financial sector.

Das wrote that “Both globally and in India, the cutting off between certain segments of the real economy and the financial markets has recently got intensified.”

“Stretched financial asset valuations pose risks to financial stability. In an intertwined financial system, banks and financial intermediaries need to be aware of these threats and spillovers.”

In order to be assured, this is not the first time that the RBI (Reserve Bank of India) has highlighted this off as a threat. Last Year, in August, it was hinted by Das that there may possibly be an imminent correction in the buoyant stock markets.

Also, the regulators stated that while the active intervention of central banks and tax authorities has been able to stabilise the financial markets, possible spillover threats have been established as a result of this disconnect between certain segments of the financial markets and the operation of the real sector.

The RBI stated that “This has implications for the banking sector in a period of continued uncertainty as its balance sheet is linked with vulnerabilities in household and the corporate sectors.”

It also stated that across the globe, abundant liquidity has led to investors attaining higher returns, widening disconnect among financial markets as well as real sector activity.

“The regulators noted that “in the spectrum of financial markets, the divergence in expectations in the equity and debt markets, both globally and in India, has also developed.”

Several supporting measures have been taken by the RBI due to the attack of the pandemic, has cautioned about the unwinding of the measures and the consequential impact this could have on the markets.

“As reflected, the support measures may have unintentional consequences, for instance, in rising equity valuations that are separate from economic performance,” said the RBI. “These disruptions from the basics, if they persist, pose threats to financial steadiness, particularly if retrieval is delayed.”