India's vulnerability to external factiors has increased

India’s vulnerability to external macroeconomic risks had increased, following the sovereign debt crisis in Europe and the uncertain global macro economic environment, the Reserve Bank of India (RBI) said in its Financial Stability Report released on Thursday. The banking regulator said global risks were likely to rise further and the recovery of advanced economies would take longer than expected.

"The adverse global developments are reflected in the external sector transactions in India. The external sector vulnerability index, based on the movements in current account deficit, ratio of current payments to current receipts, share of short-term debt to total debt and the ratio of debt stock to GDP (gross domestic product) saw an uptrend in recent times, indicating aggravation of risks from the external sector," RBI said in the report.

The central bank feels owing to the global economic slowdown, it is imperative to boost growth in the domestic economy to offset the negative impact of external shocks. "In view of the prolonged and slow global recovery, the sustainability of growth of the domestic economy hinges on resuscitation of domestic demand, especially investment, for sustained growth," RBI said. The prime driver of growth in India, especially during the previous crisis, was domestic demand which, however, is showing some weakness in recent times.

According to the report, the household sector has been more resilient than the corporate sector in the current high interest rate regime. "The impact of inflation and the rise in cost of credit on the growth in retail credit is marginal. Part of the deceleration in retail credit, however, can be attributed to the base effect," RBI said.

The earnings outlook for domestic companies shows signs of weakness, and this can be attributed to a rise in input prices, interest rates, slackening demand and some infrastructure constraints, RBI added. It said upside risks to inflation were arising from structural imbalances in the farm sector, infrastructure capacity bottlenecks, distorted administered prices of key commodities, exchange rate depreciation and widened fiscal deficit.

"Deceleration of growth and demand would adversely impact the growth in direct and indirect tax collections. With sticky oil prices and an increase in minimum support prices of key rabi crops, the subsidy expenditure is likely to be under pressure. Weak market conditions may also jeopardise the divestment plan. Fiscal slippage could increase the government’s interest cost of borrowing, which in turn could have a feedback effect on the fiscal deficit and stress," it said.