India's financial system is on a sound footing, although risks to stability from external sources persist and high and volatile oil prices are a key danger for inflation, the Reserve Bank of India (RBI) said on Tuesday.
In its annual report on the banking sector, the central bank said the domestic financial system was largely shielded from the US subprime mortgage crisis, although it was difficult to know how the problem would evolve. "However, should the current subprime mortgage crisis in the US aggravate, its impact on the Indian markets may not be significant," the report said.
It said a worsening of the crisis could impact Indian corporates who were looking to raise money in overseas markets. Foreigners could pull money of the stock market to cover losses elsewhere, which would also see the exchange rate weaken.
Governments and households may not feel any direct impact as they do not borrow from the international capital market, the report said. And while readjustments in currencies might have some impact, the overall impact would not be great as the Indian economy was largely domestic driven.
"Thus, there will be some impact. However, it may not be significant," it said. In the report the central bank said no Indian bank had a direct exposure to the US subprime market. While some banks with overseas operations had some exposure via credit derivatives, their mark-to-market losses would be limited, it said.
Earlier on Tuesday, RBI Governor Yaga Venugopal Reddy said India could not be immune to global developments despite not being directly exposed to the subprime sector.
While largely historical, the 397-page document contained an assessment on the banking sector and has some forward looking comments on the economy and the markets. The report said since India imported about 70 percent of its crude requirements, oil prices were critical in sustaining growth and maintaining price and financial stability.
"Given that pass-through from international oil prices to domestic petroleum products remains incomplete, it is a source of upside risk to inflation," it said. Global crude prices have risen by more than 53 percent from February 2007. State-set fuel prices have not been raised for more than one-and-a-half years, and the last revision was a cut in February.