Progress, Peril and Robustness - 2

Continuing from yesterday (see Progress, Peril and Robustness – 1)

Investment implications

A BIS report provides a clear map of where systemic risk is building, and reading it is a useful discipline before you decide how much risk to carry and where. Here is how I would prefer to incorporate the four pressure points highlighted in the BIS 2026 annual report in my investment strategy.

Not assuming the disinflation trade is safe

Markets have priced in resumption of the disinflation path that was underway before the Hormuz shock. The BIS’s own work suggests otherwise — energy shocks of this size have historically produced inflation effects that outlast the shock itself by a year or more, and the mitigating factors this time (anchored expectations, looser labour markets) are real but not guaranteed to hold if the shock persists. My own view: don’t fully unwind inflation hedges just because oil has pulled back from its peak. Real assets, select commodity exposure and inflation-linked instruments may still be relevant in a diversified book.

Separate the technology story from the financing story

I remain a believer in AI as a genuine productivity technology — the BIS’s own task-level studies show real efficiency gains. What worries me is not the technology; it is the financing structure around it. Circular financing arrangements — where the same dollar of capital seems to be creating revenue for multiple related entities — are exactly the kind of opacity that precedes a repricing. The practical takeaway: be diversified within your AI exposure rather than concentrated in the handful of hyperscalers and their closest financing partners, and treat any single-stock AI position as a venture-style bet, sized accordingly.

Private credit is not free lunch

The report flags that direct lending funds have quadrupled their exposure to AI and IT borrowers over five years, often with similar pricing and tenor despite growing concentration risk. Retail investors who have moved into private credit funds chasing yield should understand that liquidity terms in these vehicles can become binding constraints exactly when you need liquidity most. This is a reminder to price illiquidity properly rather than treat the extra yield as a free lunch.

Expect more volatile sovereign bond markets, not fewer

The BIS’s description of a fragile fiscal-financial nexus, where bond market liquidity can evaporate quickly, is a structural reason to expect higher volatility in developed market sovereign bonds over the coming years — not a one-off event, but a recurring feature. For fixed income allocations, this argues for staying closer to the shorter and intermediate end of the curve, and being selective about duration bets even when yields look attractive, since the BIS itself flags that governments may increasingly need central bank backstops to keep these markets functioning smoothly.

Reading the global report through a domestic lens

None of the four pressure points above originate in India, but all of them touch us, and in ways worth spelling out separately.

·         Energy dependence is our biggest transmission channel. India imports the overwhelming majority of its crude, and the BIS’s own exposure analysis places India among the emerging economies most affected by Hormuz-related disruption scenarios. A sustained oil price premium — even a modest one, well short of the panic peak — shows up quickly in our import bill, the rupee and the fiscal arithmetic. This is not a new theme for readers of this blog; it is the same fiscal-currency link I have written about before, just now driven by a fresh external trigger rather than a domestic one. (Read here and here)

·         Our macro buffers are genuinely better than in past crisis episodes, but they are buffers, not immunity. Strong bank balance sheets, healthy capital ratios and steady domestic institutional flows into equities have absorbed shocks well so far. That is a real strength. But a BIS report that flags global inflation persistence and fiscal fragility as base-case risks, not tail risks, argues for treating our own resilience as a cushion to lean on, not a reason for complacency about valuations.

·         India’s IT services sector sits directly in the AI capex cycle’s crosswinds. A continuation of the hyperscaler spending boom is a tailwind for the sector through cloud migration and AI-enabled services demand. But the BIS’s own warning about the sustainability of that capex — debt-funded, concentrated, partly circular — means a sharp AI capex slowdown, should it materialize, would hit sentiment toward Indian IT stocks even though our companies are several steps removed from the actual financing risk. Worth distinguishing between the operating exposure (mostly indirect and manageable) and the sentiment exposure (which can move faster than fundamentals).

·         The dollarization risk the BIS discusses is low for India today, given capital account management, but it is worth watching over a longer horizon as stablecoin regulation evolves globally and domestic crypto/stablecoin adoption picks up at the margins. This is more a five-year theme than a this-year theme.

·         On fixed income, the domestic story is somewhat more comfortable than the global one — our own fiscal consolidation path has been more disciplined than many advanced economies’, and RBI’s recent Financial Stability Report corroborates that domestic financial stress remains low by historical standards. But global yield volatility, if it persists, will still spill into our markets through FPI flows and benchmark repricing, so treat domestic bond market calm as conditional on the external environment staying orderly, not as a given.

To conclude: India’s relative position within this report is a source of comfort, not complacency. The buffers are real, but the report is fundamentally about a world where shocks have become more frequent and financial systems have become more interconnected in ways that are hard to see until they matter. Being well-diversified, avoiding concentrated bets on any single global narrative — AI, energy, or otherwise — and keeping some genuinely defensive assets in the mix remains the right posture, regardless of how sound our own banking system looks on paper.

There is a line from the Gita that I keep returning to in years like this one: योगस्थः कुरु कर्माणि सङ्गं त्यक्त्वा धनंजय — perform your actions established in yoga, having abandoned attachment. The BIS report, at its core, is a document about attachment: to easy financial conditions, to a single technology narrative, to the assumption that resilience shown once will hold indefinitely. The investor’s job, as always, is to keep doing the work — reading, rebalancing, staying diversified — without becoming attached to any one story about how the world must unfold.

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Progress, Peril and Robustness - 1