Stable government spells brighter economic recovery prospects: RBI

A stable government at the centre has brightened the prospects of India's economic recovery, the Reserve Bank of India said in a report on Thursday, adding that more steps were needed to stock up supplies to tame inflation.

The central bank's latest Financial Stability Report struck a note of caution about the deteriorating asset quality of state-owned banks amid concerns over high bad loans (See: Indian banks face risk of worsening asset quality: RBI report).

"Going forward, with the formation of a stable government, the prospects of recovery appear bright," the RBI said in the report. "However, supply side constraints need to be addressed to complement the RBI's efforts to contain inflation expectations.

"India's financial system remains stable, although public sector banks face challenges in coming quarters in terms of their capital needs, asset quality, profitability and more importantly, their governance and management processes," RBI governor Raghuram Rajan said in the report.

The Indian economy has grown at less than 5 per cent for two successive years, hit by high inflation and borrowing rates.

The Narendra Modi-led NDA rode to a landslide victory in the recent polls, but faces the challenge to deliver quickly on its electoral promises to cool inflation and revive the economy from the slump.

"Markets expect more decisiveness in government policy formulation, as well as greater efficiency in implementation," Rajan said, and added that a predictable tax regime along with low and stable inflation will be key to financial stability.

The RBI also underlined the need for fiscal consolidation. "The adverse growth-inflation setting obtained over the last two years which continue to affect saving investment dynamics, poses a major challenge. A strong push to implement policy is expected to provide the necessary impetus to the investment cycle," it added.

"While capital expenditure, mainly for developing infrastructure, is vital for growth, fiscal consolidation also remains a policy imperative. A greater role for private sector investment in capital-intensive sectors is warranted. Activity in domestic equity markets continued to be dominated by foreign institutional investors," it said.