AI valuation correction could boost capital flows to India, but poses global financial risks: RBI Governor

As per the latest business developments, A correction in elevated artificial intelligence-linked valuations in advanced economies could redirect capital flows towards India, even as a slowdown in the global AI investment cycle poses risks of sharp asset repricing and financial-market volatility, Reserve Bank of India (RBI) governor Sanjay Malhotra stated on October 3.

“The AI investment cycle has been a major backing for global markets,” Malhotra stated at the Kautilya Economic Conclave in New Delhi. That stated, any slowdown in AI investment or earnings could “trigger a sharp repricing of financial assets, especially in the AI value chain”, he warned.

For India, such a correction could have a potentially favourable impact on overseas flows.

“As for corrections in AI-related valuations, if they were to happen in advanced countries… it may have a positive impact in terms of capital inflows,” Malhotra stated.

Indian equity markets have already corrected from elevated valuations in recent months, but the adjustment has remained orderly, he further noted.

AI emerges as financial stability risk

The rapid expansion of artificial intelligence has emerged as an important source of backing for global equity markets, particularly in advanced economies, but Malhotra warned that AI use could additionally create vulnerabilities.

Malhotra listed stretched AI among five major risks at present facing the global financial system, alongside elevated global debt, leverage in non-bank finance, private credit and cyber threats.

He stressed that none of these risks individually represented an imminent threat.

“It is not that I see any imminent signs of stress,” Malhotra stated. “But we need to remind ourselves that we need to stay alert to these risks.”

Malhotra stated India was navigating the current global uncertainty from a “position of resilience”, supported by firm macroeconomic fundamentals and resilient balance sheets of banks and non-bank financial institutions.

While India stays exposed to external shocks through commodity prices, global financial conditions and capital flows, he stated the domestic financial system remained resilient.

“Firm macroeconomic fundamentals and the resilience of the financial system provide confidence in our ability to withstand these lingering shocks,” Malhotra stated.

Next financial crisis could come from outside

“With the development of sophisticated AI tools… the most immediate concern is regarding cyber risk,” he stated.

Large differences in cybersecurity capabilities and the ability to respond to attacks across countries meant that a vulnerability originating in one jurisdiction could have consequences well beyond its borders.

The next financial crisis, Malhotra stated, may as a result not originate in the banking system itself.

“It may begin with a geopolitical event, a cyberattack or a technological failure that affects the financial system through multiple channels,” he stated.

This required regulators to better understand interconnectedness, technological dependencies and potential channels of contagion across the financial system.

“Today's resilience may not necessarily imply tomorrow's immunity,” Malhotra stated.

Financial system must absorb shocks

Malhotra stated regulators should not attempt to eliminate every financial risk, as doing so could constrain investment and innovation.

“Attempting to remove all risks would curtail innovation and investment,” he stated.

Instead, the objective should be to ensure that the financial system can absorb shocks without amplifying their impact on the wider economy.

“We cannot prevent every shock,” he stated. “What we can ensure, that stated, is that the financial system acts as a shock absorber.”