Slowdown in growth is the most worrisome factor and volatile capital flows have made the country vulnerable to "stops and reversals", RBI Governor D Subbarao said on Thursday.
The RBI Governor, however, said the growth outlook for the current fiscal is relatively optimistic, helped by measures taken to ease the supply bottlenecks.
"The slowdown in growth is the most worrisome factor as industrial activity is stubbornly subdued and services remain below the trend," Subbarao said in his foreword to the seventh Financial Stability Report released by the RBI this evening.
Even as RBI is estimating growth to improve to 5.7 per cent the governor pointed out that overseas bodies like the IMF and the World Bank have also given an optimistic forecast.
Growth touched a near-decadal low of 5 per cent in FY13. With inflation easing and positive actions from the government on the fiscal deficit front, RBI has taken the growth-propping measure of cutting rates but has been of late held back by high current account deficit.
Subbarao flagged the issue of volatile capital flows, saying they are making the country "vulnerable to sudden stops and reversals".
This trend was seen recently following the "slightest hint of exit from quantitative easing by the US Federal Reserve", he said.
Subbarao said that the short-term efforts are directed at financing the current account deficit, which touched a record high of 4.8 per cent in FY13, though the last quarter of the fiscal saw a massive improvement to 3.6 per cent from 6.7 per cent in the previous quarter.
He said the perception of difficulties in doing business in the country still persist and noted that this is inhibiting investments in the country.
"There is a need to introspect as to why we rank low(111/144 in economic freedom index and 59/144 in global competitive index) and keep slipping in the rankings," Subbarao said.
He also reiterated the lessons from the post-Lehman financial crisis in 2008, saying the crisis has demolished the myth that growth can be driven by financial engineering.
"We now know that the financial sector has no standing of its own; it matters only to the extent that it aids the growth of the real sector," Subbarao said, adding that it is this wisdom that should guide both the global community and the Reserve Bank.
The RBI report said that the asset quality of banks has improved in the final quarter of last fiscal with the gross non-performing assets ratio of the system declining to 3.4 per cent of the total loan outstanding, from 3.6 per cent in the September quarter.
This had a positive impact on the net NPAs of banks, which improved to 1.4 per cent of the total loans outstanding in the March quarter from 1.6 per cent six months ago in the September quarter, it said.
"The improvement was due to lower slippages, improved recovery and higher write-offs during the March quarter," it added.