RBI sees fragmented geopolitics, AI bubble as biggest threats to Indian economy

A sharp correction in global equity markets could spill over into Indian markets, particularly if driven by a reassessment of earnings growth and elevated valuations in AI-related stocks, the Reserve Bank of India has warned.

“The global economy and financial system are being reshaped by two profound forces—growing geopolitical fragmentation and technological disruption brought about by rapid advances in AI,” RBI governor Sanjay Malhotra said in his foreword to the central bank's half-yearly Financial Stability Report released on Tuesday.

Inflationary pressures may require central banks of major advanced economies to remain hawkish, potentially tightening global financial conditions, Malhotra said. Further, vulnerabilities from high public debt, bond market fragilities, stretched asset valuations, and the growing footprint of leveraged non-bank financial intermediaries could amplify the impact of future shocks, he said, adding that the near-term outlook remains uncertain and global financial stability risks remain elevated.

Though headwinds from the West Asia conflict are receding, the Indian economy and financial system remain susceptible to geopolitical tensions and associated shocks. “Exchange rate volatility may rise if oil prices increase due to the delayed normalisation of supply chain disruptions and additional demand to replenish inventory,” the report said.

Increasing interconnectedness across entities and sectors, while indicative of deeper financial integration, could also act as an additional channel for shock transmission and therefore merits close surveillance, it added.

The RBI Financial Stability Report, published at the end of June and December every year, includes contributions from all financial sector regulators, presenting a collective assessment on current and emerging risks to the stability of the Indian financial system.

Economic resilience

Despite global headwinds, India’s macroeconomic fundamentals are strong compared to many of its peers and compared with previous episodes of crisis, which provide important buffers to withstand these shocks, Malhotra said, adding that stress tests undertaken by the central bank indicate that financial institutions are well-positioned to withstand these adverse shocks.

The stress test results indicate that the banking sector remains well-positioned to absorb potential shocks, with capital ratios projected to remain comfortably above regulatory thresholds even under adverse conditions. The NBFCs are financially sound too, supported by strong capitalisation, healthy profitability, and improving asset quality. However, stress tests indicate that a few entities could face pressure under severe stress conditions.

On the whole, strong growth, low inflation, healthy balance sheets of financial and non-financial firms, and ample buffers have helped preserve macro-financial stability, Malhotra said, adding that the RBI recognises that maintaining public confidence in the financial system requires more than “prudential soundness”. “In this environment, preserving financial stability, strengthening the financial system and building systemic resilience have become more important than ever.”

The Indian economy grew 7.7% in FY26, faster than 7.1% in the previous year. In Q4, the GDP grew 7.8%, slower than 8% in the previous quarter, owing to a sharp decline in manufacturing growth.

On the other hand, India's retail inflation, as measured by the Consumer Price Index (CPI), rose to 3.93% in May 2026 from 3.48% in April, primarily due to higher food and fuel costs.

“Even amid an uncertain global backdrop, the potential for external shocks to generate systemic financial stress and spill over to the real economy remains contained,” the report said, adding that the balance of risks has shifted favourably, supported by the cessation of hostilities in the West Asia conflict and the recent policy measures by the government and RBI to strengthen capital inflows.

On 6 June, the RBI and government simultaneously unveiled a slew of measures to draw foreign capital into local debt markets and support the rupee. These comprised wider access for foreign investors to government securities, tax exemptions on investments in sovereign bonds, relaxed investment restrictions for foreign investors, and higher equity investment limits for overseas individuals.

The central bank has also announced a concessional forex swap facility for public sector undertakings to raise funds through external commercial borrowings and a special window to attract three-, and five-year foreign currency non-resident - bank, or FCNR(B), deposits till 30 September 2026.