(c) 2013, Bloomberg News.

(c) 2013, Bloomberg News.

MUMBAI The Reserve Bank of India said the nation's economic and monetary policies must preserve financial stability as the prospect of reduced U.S. Federal Reserve stimulus contributes to a slide in the rupee.

Currency weakness could stoke already "high" consumer- price inflation, the Reserve Bank said in its annual report released here Thursday. Other challenges include a current- account deficit that exceeds sustainable levels, slowing growth, budget-deficit risks and rising bad loans at banks, it said.

The rupee touched an unprecedented low Thursday as concern the Fed will taper stimulus prompts investors to pull billions of dollars from emerging markets. The RBI plans to buy long-dated government debt tomorrow after engineering a cash squeeze last month to support the currency, a step that imperiled economic expansion by prompting a surge in bond yields.

"The RBI has no choice but to maintain financial stability at this point, which means sacrificing growth in the near term," said Tirthankar Patnaik, a strategist at Religare Capital Markets Ltd. in Mumbai. "Investors will write off India if structural issues remain unresolved and feed into chronic deficits and prices, and if growth stays subdued."

The rupee touched an all-time low 65.56 per dollar Thursday and has tumbled 15 percent in 2013. The yield on the 7.16 percent government bond maturing May 2023 fell to 8.23 percent from 8.41 percent yesterday. The S&P BSE Sensex index rebounded 2.3 percent.

"Macroeconomic and monetary policies need to be carefully calibrated to achieve the immediate objective of maintaining stability without comprising growth," the central bank said.

The monetary authority reiterated that the steps since mid- July to tighten liquidity "are intended to be rolled back in a calibrated manner" as the rupee stabilizes, so that policy can revert to supporting growth and containing inflation.

The Reserve Bank since July 15 has raised the marginal standing facility and bank rates, capped cash injections into the banking system and tightened lenders' daily reserve requirements to curb the supply of rupees. On Aug. 20, it announced plans to buy long-dated government debt.

"Utmost attention" is needed to contain rising financial stability risks from deteriorating asset quality at banks, the central bank said in the report.

The current-account gap may narrow in 2013-2014 from the record 4.8 percent of gross domestic product in the 12 months ended March, while remaining "much above" the sustainable level of 2.5 percent of GDP, the RBI said.

Finance Minister Palaniappan Chidambaram said last week curbs on gold and silver imports and plans to compress inward shipments of non-essential items will trim the current-account gap to $70 billion, or 3.7 percent of GDP, this fiscal year.

The government began reforms in September 2012 to restrain the budget deficit, accelerate stalled infrastructure projects and ease restrictions on foreign investment in industries from aviation to retailing.

The administration is striving to avert a credit-rating downgrade that may hurt India's ability to fund the trade imbalance. Fitch Ratings said Thursday recent pressures on India's markets aren't a trigger for rating action at this point.

Consumer prices rose 9.64 percent in July from a year earlier, the second-fastest in the Group of 20 major economies. Wholesale prices advanced 5.79 percent, exceeding the central bank's comfort zone of about 5 percent.

India's $1.8 trillion economy will expand 5.5 percent in the year through March 2014, central bank estimates show, compared with a decade-low 5 percent in the previous 12-month period as investment moderated.

About 826 million of India's 1.2 billion people live on less than $2 per day, according to the World Bank.

"Recovery is possible and can take shape later in 2013-2014, but is predicated on better governance, the removal of supply constraints and maintenance of stability," the central bank said. Healthy monsoon rains augur well for agriculture and rural demand, the RBI said.

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