Risks to India's macro-economic stability have increased on the back of an economic slowdown, high inflation, and ballooning fiscal and current account deficits, the Reserve Bank of India said in a report on Friday.
A slowdown in both domestic savings and investment demand, as well as a moderation in consumption have also emerged as threats to macroeconomic stability, the central bank said in its financial stability report (FSR).
"The overall macro-economic risks in the Indian financial system seem to have increased since the publication of the previous FSR in June 2012," the RBI wrote in the report.
India's economy is expected to grow 5.7-5.9 percent for the fiscal year ending in March, the slowest since 2002/03. Growth prospects also remain below the recent trend of double-digits, with Prime Minister Manmohan Singh this week calling the five-year government plan for 8 percent expansion "ambitious."
The current account deficit also remains a concern as Asia's third largest economy has seen exports fall due to weak demand in key markets like the United States and Europe, while imports of gold and oil have remained high.
On the fiscal side, the government could see a shortfall in tax and non-tax revenue because of the economic slowdown, and is at risk of overshooting its expenditure targets, the RBI said.
The RBI added data from banks showed a significant portion of foreign exchange exposures at companies remained unhedged, posing another risk to macro-economic stability.
"This is especially disquieting given that the exchange rate volatility has been higher in India in comparison to other emerging market currencies as well as those of advanced economies," the central bank wrote in the report.
The RBI also said profitability at banks may come under pressure in coming quarters with gross non-performing assets (NPA) continuing to tread above the credit growth and on the back of rising slippages.
State-run banks saw a high degree of deterioration in asset quality compared with its peers. The gross NPA for all banks rose to 3.6 percent at the end of September versus 2.9 percent at the end of March, the central bank said.
The RBI said if the adverse macroeconomic conditions persists, the system level gross NPA could rise from 3.6 percent at end of September to 4 percent by end of March 2013 and 4.4 percent by end of March 2014.