India must avoid sway of fin mkts' expectations over macro outcomes: CEA

Speaking at the CII Financing 3.0 Summit in Mumbai, Nageswaran stated that when the financial sector is in excessively robust health, the health of the rest of the economy becomes fragile

Chief Economic Advisor (CEA) V Anantha Nageswaran on Monday warned that as financial markets become bigger than the economy, it is natural, but not reasonable, that the priorities of the financial market dominate macroeconomic outcomes. But India, which looks ahead to 2047, should avoid this trend as its consequences in the developed world are there for all to see, he said.

The dominance of the financial market over policy and macroeconomic outcomes is referred to as financialisation.

Speaking at the CII Financing 3.0 Summit in Mumbai, Nageswaran said when the financial sector is excessively robust, the health of the rest of the economy becomes fragile.

“India’s stock market capitalisation (mcap) is around 140 per cent of gross domestic product (GDP). The record profitability of the Indian financial sector and the high levels of mcap or its ratio to GDP gives rise to another phenomenon, which needs to be examined,” he said.

The CEA said financial markets were not the most reliable barometer of risk and reward. “If they are not, they cannot be trusted to direct available savings to its most efficient applications”.

Nageswaran drew attention to the developed economies, where financialisation has led to unprecedented levels of debt, dependency on rising asset prices for growth, and increased inequality. India, still a lower-middle-income country, must avoid these pitfalls, he said, adding that India could ill-afford the financialisation and its ramifications that afflict advanced societies.

Commenting on the impact that Federal Reserve’s easing policy would have on India, he said there was no more the risk of the episode of 2008, which led to a surge in capital flows leading to unproductive investments.

“If the Fed rate cuts also end up coinciding with the rise in uncertainty because of geopolitical effects, then the question is whether the rate cuts in and of themselves will necessarily result in capital inflows, because other things are not remaining constant,” Nageswaran said.

He stressed that India must find and keep the right balance between national imperatives and investor interests or preferences. “It also means becoming a global agenda-setter rather than an agenda-taker. While some actions can be initiated now, such as, for example, an Indian entity making an effort to become a global-credit rating agency, the outcome and impact will take much longer to materialise,”

Nageswaran also emphasised the financial sector’s importance over other sectors as it requires higher responsibility because the impact of what happens in the financial sector reverberates throughout the economy.

“The big difference between the financial sector and other sectors is that the consequences of what happens in this sector reverberate throughout the economy and beyond, carrying, therefore, a significant weight of responsibility on its shoulders,” he said.

He said the dominance of banking support to credit had been reduced and was getting replaced by the financial sector both in terms of product and participants which is a well-intended move for the country. Meanwhile the sector has to ensure that as it grows in size and importance, it avoids the mistakes that its developed counterparts committed over the years.