Slow and halting recovery in advanced economies, inflationary pressure, currency rise because of capital inflows and widening of current account deficit pose risks to the country's economic growth, the Reserve Bank of India (RBI) said today.
The central bank in its second quarterly review of the monetary policy has retained the projected growth of 8.5 per cent for the Indian economy during the current fiscal.
However, it said, that the "macroeconomic and monetary projections are subject to a number of upside and downside risks".
The main downside risk to growth emanates from the prospects of a "prolonged slow and halting recovery process in advanced economies, as evidenced by the recent indicators of global economic activity", the policy said.
"Should the global recovery falter, the growth performance of emerging market economies (EMEs), including India which has remained robust so far, is likely to be adversely affected," it said.
The IMF has projected that global growth may slow down from 4.8 per cent in 2010 to 4.2 per cent in 2011.
The policy lists inflation as another key challenge facing the policy makers.
Despite the fragile global recovery, international commodity prices have risen in recent months due to strong demand from EMEs and some "financialisation of commodities" due to large surplus global liquidity.
"Going forward, therefore, the risks to inflation are largely on the upside," the RBI said.
The inflation for September stood at 8.6 per cent, much higher than the RBI's comfort level of 5-6 per cent.
Large capital inflows are coming from advanced countries to the emerging economies like India.
As a result, exchange rates have been appreciating and asset prices have been rising in EMEs, the RBI said.
"Although India needs capital flows to finance its widening current account deficit, large capital flows beyond the absorptive capacity of the economy could pose a major challenge for exchange rate and monetary management," it said.
India's current account deficit has widened in the recent period due to slowing down of exports and high net invisibles on the one hand and rising imports on the back of strong rebound of the domestic economy on the other.
"...The widening of the current account deficit (CAD) raises concerns given the uncertainty associated with international capital flows," the Governor said.
CAD was around 3.6 per cent of GDP in the first quarter of 2010-11.
Besides, rising asset price is also a concern, the RBI said.
