Subprime crisis might spread, says RBI

The Reserve Bank of India (RBI) has said financial stability in India could assume greater importance in coming months amid fears the US subprime mortgage crisis might spread.

In its annual report for the year ended June 2007, the central bank has pointed out that the implications of the recent disruptions caused by the global credit crunch on the global economy are not yet clear.

If the US economy were to experience a sharper slowdown because of a broader-than-expected impact of the housing sector difficulties, the spill-over effects into other economies would be larger and decoupling from the US would be more difficult.

It said inflationary pressures could persist in India due to shortfalls in agricultural and infrastructure outputs, which would constrain continuing and more broad-based growth.

The central bank has said certain critical elements need to be addressed to avoid risks of financial imbalances and recurrence of inflation (see table).

The RBI said the economy was possibly on the threshold of a step-up in growth, provided the vigilance on price stability, including financial stability, was intensified. The RBI's inflation target for 2007-08 is 5 per cent and GDP growth 8.5 per cent against 9.4 per cent in 2006-07.

Inflation has dropped to just above 4 per cent this month from a two-year high of 6.69 per cent in January after the RBI raised its short-term lending rates five times since June 2006 and increased the portion of deposits banks need to keep with the central bank by 200 basis points since December 2006 to 7 per cent.

"A continuous vigil supported by appropriate policy actions ...would be needed to maintain price stability so as to anchor inflationary expectations on a sustained basis," it said.

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The concerns

Financial stability in India to assume greater importance

US subprime crisis may lead to a more significant global credit tightening

Capital withdrawal from emerging markets likely on further deterioration due to subprime crisis

Growth impulses in India getting more broad-based but shortfalls in farm and infrastructure are constraints

...and the solutions

Remove infrastructure constraints

Improve domestic investment climate, particularly for SMEs

Step up growth of agriculture, particularly foodgrains

Fiscal empowerment with emphasis on higher provision for education, health, water and sanitation

Intensified vigil on price and financial stability

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