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India is vulnerable to high public debt - RBI

MUMBAI (Reuters) - India’s economy is vulnerable to high public debt and global developments but there is no visible immediate threat to financial stability, the governor of The Reserve Bank of India (RBI) said on Thursday.

Reserve Bank of India (RBI) Governor Yaga Venugopal Reddy is seen in Mumbai in this file photo. REUTERS/Punit Paranjpe

“A major area of vulnerability for us is the high consolidated public-debt to GDP ratio of over 70 percent ... (and) consolidated fiscal deficit,” Yaga Venugopal Reddy said in Hyderabad.

He said the Indian economy remained prey primarily to global developments.

“I also agree... that susceptibility arises essentially from global developments and hence I will treat this as another advice to us to be vigilant in managing the process of integration with the global economy,” he said.

The speech was posted on the central bank’s Web site,

While central banks had provided liquidity support to cope with a global credit crunch, the scope for financial contagion to other economies could not be ruled out and it was not clear how it would unfold in 2008, he said.

“There is one uncertainty in these circumstances ... extraordinarily uncertain times are ahead of us,” he said.

“While there is no visible immediate threat to financial stability in our country, at this juncture, we recognise the need for continued but heightened vigilance,” he added.

Earlier, speaking at an another event, Reddy said it was necessary to encourage expectations of greater flexibility in the rupee exchange rate, and India was gradually moving towards this goal.

However, the economy’s response to exchange rate movements was not likely to be as flexible as in advanced countries and policymakers had to encourage greater flexibility among business, he said.

“At the same time, the pressure for change cannot be to such an extent that the volatile exchange rate movements seriously disrupt the business environment,” Reddy said.

The rupee rose more than 12 percent against the dollar in 2007, hitting the competitiveness of exporters and raising doubts about whether a $160 billion export target for the fiscal year ending on March 31 would be met.

The RBI bought $64.5 billion in the first 10 months of 2007 trying to contain the currency’s rise. It raised banks’ reserve requirements and sold intervention bonds to drain the cash released by its dollar purchases, which could otherwise add to inflation pressures.

Reddy said encouraging outflows as a way of managing surging inflows may not work in the short run, as a more open liberalised regime tended to also attract more inflows.

“While recourse to some encouragement to outflows such as the liberalisation of overseas investment by our corporates in the real sector is helpful, it has to be combined with other measures to manage the flows depending on their intensity,” he said.

Reddy said a judgment needed to be made on whether capital flows were of a temporary or permanent nature. He said a prudent first reaction was to treat all large inflows as temporary, and if they resulted in excess volatility in the markets, then intervention was necessary.

“Overall, the portfolio investments could be expected to be less stable than foreign direct investment,” he said.

Additional reporting by V. Ramakrishnan and Anurag Joshi