Calling for structural reforms to reinforce investor confidence, the Reserve Bank of India (RBI) on Monday said that falling inflation and political stability have helped check the macroeconomic vulnerabilities, while retail inflation is expected to stabilise near 6 per cent level in 2015.
On the gross non-performing assets (GNPAs) of the banking system, the central bank said it is likely to drop to 4 per cent by March 2016 with expected improvement in macroeconomic indicators going forward.
The observations have been made by RBI in its latest Financial Stability Report (FSR).
The central bank, however, flagged lower revenue mobilisation this fiscal as a "major concern" and said that the asset quality remains a grey area in the banking sector.
It also sounded caution over the recent phenomenon of FIIs showing greater interest in the Indian debt markets, saying this trend can turn volatile in the wake of changes in global markets, especially in the US, the world's largest economy.
If the US surprises investors with changes in its monetary policy, there might be certain adverse impact on domestic markets, RBI said.
"On the domestic front, macroeconomic vulnerabilities have abated significantly in recent months on the back of improvement in growth outlook, fall in inflation, recovery in external sector and political stability," the FSR noted.
Inflation, a guiding factor which has resulted in the elevated rate structure, will be at 6 per cent-mark for 2015, up from the 4.4 per cent in November 2014, it said.
"The Reserve Bank's latest projections suggest that CPI inflation over the next 12 months may hover around 6 per cent if international crude prices remain at the current levels and monsoon next year turns out to be normal."
The RBI acknowledged investor optimism over the India growth story and said the challenge ahead for the government is to deliver "commensurate structural reforms".
The central bank, which has voiced its worry about the fiscal deficit, flagged lower revenue mobilisation this fiscal as a "major concern".
As for the recent phenomenon of an increase in FII interest in Indian debt, RBI sounded caution, saying it can turn volatile, reacting to changes in global markets, especially in the US, the World's largest economy.
If the US surprises investors with changes in its monetary policy, there might be certain adverse impact on domestic markets, it said.
On bad loans, the RBI said, "the macro stress tests for credit risk suggest that under the baseline scenario, which assumes improvement in the overall macroeconomic scenario during the next financial year, the GNPA ratio of all SCBs may decline to 4 per cent by March 2016 from 4.5 per cent as at end September 2014."
The report, however, warned that if macroeconomic conditions deteriorate, the GNPA ratio of scheduled commercial banks (SCBs) may increase further and under a severe stress scenario it could rise to around 6.3 per cent by March 2016.
"Under such a severe stress scenario, the system level CRAR (capital to risk weighted asset ratio) of banks could decline to 9.8 per cent by March 2016 from 12.8 per cent in September 2014."
The net non-performing advances (NNPAs), as a percentage of total net advances, increased to 2.5 per cent in September 2014 from 2.2 per cent in March 2014.