Indian banks could face increased risks from global fiscal problems and volatile oil prices as the economy opens up slowly to foreign competition, the central bank said on November 24.
"Global financial imbalances continue to grow with the US current account deficit now ruling at above 6 percent of its gross domestic product," the Reserve Bank of India said in its Report on Trend and Progress of Banking in India, 2004/05.
"There is risk of currency readjustments which could cause heightened volatility in the financial markets through changes in exchange rate and interest rates."
India's central bank gives more emphasis to domestic factors like growth and inflation while formulating monetary policy, but US interest rate movements have also been a key driver as they impact foreign capital investment.
Robust inflows of $8.5 billion into local stocks in the first nine months of 2005 had supported the rupee until September. But when investors pulled out $800 million in October, the rupee fell to a 13-month low of 46.06 a dollar earlier this month.
The partially convertible rupee has since bounced back and was trading at 45.71 on Thursday evening.
The central bank also warned banks that they could suffer significant losses on their investment portfolio if interest rates rose sharply.
India's 10-year bond, which touched a record low of 4.94 percent in October 2003, was at 7.05 percent on Thursday. The central bank has raised short-term interest rates three times since October 2004 to fight inflation caused by robust domestic growth and high oil prices.
India imports about 70 percent of its oil but while world prices have climbed more than 35 percent this year, New Delhi has raised domestic fuel prices by only 15 percent. India's wholesale price inflation is at 4.14 percent and the central bank expects it to end the year to March at 5.0-5.5 percent.