India has large twin deficits, high prices of some real assets, and (less familiar) fragile financial interdependence between banks and the government. So there is a systemic risk. However, India has a reasonably good record so far with regard to avoiding financial crises. This is due to five mitigating factors: (a) financial repression in banks; (b) unanticipated jumps in inflation rate; (c) somewhat regular bailouts; (d) misplaced confidence; and (e) good growth. The first three factors have ‘persistent’ costs. There are reasons to believe that these costs are high. The fourth factor is not a reliable ‘hedge’ against systemic risk. Finally, growth is a camouflage rather than a solution. The bottom line is that there is a serious problem at hand even if there has been no ‘financial crisis’ for long. We make long-term policy suggestions in this extensive but simple analytical article on the economic aspects of macro-financial stability.
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