Global Financial System Faces Valuation and Debt Risks, RBI Governor Malhotra Says

The global financial system remains vulnerable to stretched valuations of risk assets, expanding public debt and rising interconnectedness among banks and non-bank financial institutions, Reserve Bank of India Governor Sanjay Malhotra cautioned in the foreword to the central bank’s December Financial Stability Report.

Governor Malhotra noted that 2025 tested the resilience of the global economy amid geopolitical conflicts, trade tensions and persistent policy uncertainty. Growth and financial stability held up better than feared, yet the outlook for 2026 and beyond remains clouded by policy paths that are still evolving and largely untested.

Valuation Risks
The RBI report said elevated risk appetite, abundant liquidity and easy financial conditions have pushed equity prices and gold to elevated levels globally, raising the risk that a sharp correction could trigger fire sales as asset correlations shift abruptly.

It also flagged fiscal strains in advanced economies as a key fault line. Borrowing needs remain well above pre-pandemic levels, with no clear signs of reversal. Rising interest costs, ageing-related healthcare spending and higher defence outlays have lifted long-term borrowing costs.

Widening swap spreads point to growing investor reluctance to hold long-term sovereign debt and the higher risk premium now demanded, even as authorities rely more heavily on short-term issuance to fund incremental borrowing. These dynamics heighten rollover and refinancing risks and could amplify volatility during periods of market stress.

The growing role of non-bank financial intermediation, private credit and digital financial innovations such as stablecoins is expanding access and efficiency, while layering new risks onto an already tightly interconnected system. The RBI warned that shocks could transmit more quickly across institutions and markets, particularly if confidence in risk assets weakens.

Against this fragile global backdrop, the report said the Indian economy and financial system continue to demonstrate resilience. Domestic growth surprised on the upside in the first half of 2025–26, with real GDP expanding 7.8% in the April–June quarter and 8.2% in the July–September quarter, supported by strong private consumption and sustained public investment.

Low inflation, easy financial conditions, a favourable monsoon, tax reforms and the expansion of digital public infrastructure have reinforced momentum.

Debt Pressures
The report also highlighted emerging pressures in domestic debt markets. Net issuance of central and state government securities has risen sharply, outpacing last year’s levels. Demand from traditional long-term investors such as banks, insurers and pension funds has softened, with banks tilting towards state securities and institutional investors increasing equity exposure.

Elevated state-level debt and high committed expenditure could keep borrowing needs and yields firm, even as the overall debt-to-GDP ratio stabilises around 82%.