Risks to financial sector stability

Sangita Mehta, Gayatri Nayak & Shilpy Sinha

External Sector Vulnerability

It is not just the current account deficit, or CAD, all major indicators of external sector vulnerability continue to deteriorate. While short-term debt and volatile component of capital flows are on the rise, the number of months’ of imports that the forex reserves can finance too is falling.

This is because exports have slowed down, but imports have not. Besides, other stable sources of capital flows such as FDI have also slowed. As a result, the cushion of forex reserves is weakening. A sharp deterioration in the level of reserves could adversely impact the sentiment of overseas investors.

RBI is concerned that given the high CAD, any adverse development in international financial markets could impact the domestic foreign exchange markets severely if macroeconomic fundamentals are not very strong.