Liquidity, credit and FPI inflows buoy financial markets in July

• Domestic financial conditions eased in July, the CRISIL Financial Conditions Index (FCI) shows. FCI, a summary indicator capturing India’s major market segments1, rose to 0.8 in July from 0.5 previous month
• The global environment was broadly conducive as investors geared up for imminent rate cuts by the US Federal Reserve (Fed). Foreign portfolio investor (FPI) inflows rose sharply to debt and equity markets. India’s formal inclusion in the JP Morgan Emerging Markets Bond Index at the end of June also gave a fillip to debt market FPI inflows
• Domestically, liquidity conditions improved and interest rates eased across money and debt markets. For the broader economy, bank credit growth strengthened in the month
• Amid sustained strong credit growth, the RBI governor flagged the need to monitor excessive leverage in certain retail segments mostly for consumption purposes. It flagged high growth in home equity loans and gold loans. The latest sectoral bank credit does indeed show strong growth in these segments
• The governor highlighted a wide credit-deposit gap in the banking system, which could create structural liquidity issues. Bank deposit growth at 11.3% as of mid-July trailed 15.5% bank credit growth
• Lagged transmission of RBI’s past rate hikes coupled with regulatory measures to clamp down risky credit is expected to moderate credit growth this fiscal
• Globally, monetary policies are diverging, which induced some market volatility in early August. However, India’s low external vulnerability and record-high foreign exchange reserves provide comfort. With the Fed expected to cut rates from September, the RBI will have more room to move towards a rate cut