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The Reserve Bank of India (RBI), in its bi-annual Financial Stability Report released on Tuesday, said India's financial system remains resilient despite mounting risks to global financial stability arising from the ongoing conflict in West Asia.

The report, however, cautioned that the Indian economy continues to face risks from exchange rate volatility, energy price shocks and inflationary pressures linked to the geopolitical situation.

Strong Fundamentals Provide Buffer Against External Shocks

According to the RBI, India's financial sector has remained resilient in a challenging global environment, supported by healthy capital ratios, comfortable liquidity buffers and non-performing asset (NPA) ratios at multi-decadal lows.

The report said India's strong macroeconomic fundamentals place it in a better position than many of its peers, providing greater resilience against external shocks.

At the same time, it noted that the country's dependence on imported oil and other key commodities leaves the economy vulnerable to energy price shocks and supply chain disruptions.

West Asia Conflict Impacts India Through Financial Channels

The RBI said the uncertainty stemming from the West Asia conflict has affected emerging market economies, including India, through financial channels.

"The exchange rate came under sustained depreciation pressure due to weakening of capital inflows and higher hedging demand from importers and investors. Notwithstanding sustained fiscal consolidation, government bond yields, especially at the longer end, came under pressure mainly reflecting geopolitical tensions and rising energy prices," the report said.

Despite these headwinds, the RBI said India continues to be the fastest-growing major economy, supported by domestic demand, while inflation remains within the target range.

Report Highlights Pressure On Rupee And Bond Yields

The report flagged the depreciation of the Indian rupee, attributing it to weaker capital inflows and increased hedging demand from importers and investors.

It also noted that longer-term government bond yields came under pressure despite continued fiscal consolidation, largely due to geopolitical tensions and higher energy prices.

However, the RBI said that improving sentiment over developments in West Asia, along with measures taken by the central bank and the government, has helped ease pressure on both the exchange rate and bond yields.

Recovery Seen, But Risks Persist

The report noted that recent months witnessed underperformance in Indian equities, with several stocks touching fresh lows and foreign portfolio investors (FPIs) undertaking significant sell-offs. It said the weakness was partly linked to concerns over the potential impact of artificial intelligence and India's exposure to supply-side disruptions.

Following the sharp correction in equity markets, however, the report said the Indian economy has demonstrated greater resilience, supported by strong macroeconomic fundamentals.

RBI Warns Against Future Global Market Shocks

While acknowledging that geopolitical tensions have eased following an interim peace deal between the US and Iran, the RBI cautioned that India's economy and financial system remain vulnerable to geopolitical developments and related shocks.

"A sharp correction in global equity markets, particularly if driven by a reassessment of corporate earnings growth and elevated valuations in AI related stocks, could spill over to domestic markets," the report added.