Mumbai, Aug. 30: The Reserve Bank of India (RBI) today said growth in the economy remained robust, but two factors could poop the party: runaway inflation precipitated by rising commodity prices, especially crude oil, and the rippling effects of the sub-prime housing mortgage crisis in the US.

The central bank, which released its annual report for 2006-07 here today, said there were clear indications that the growth momentum would pick up pace this year.

Steady increases in gross domestic saving and investment rates, consumption demand, addition of new capacity and efficient utilisation of existing capacity were expected to underpin India’s remarkable growth story in which real GDP growth had averaged 7.6 per cent during the Tenth Plan (2002-07) — the fastest expansion in any plan period.

However, the central bank remained uneasy about inflation which could raise its hydra head once again even though it had softened in the past few months.

“Inflation can emerge as the key downside risk to the evolving macroeconomic outlook,” it warned, adding that it was necessary to assess risks to the inflation outlook emanating from high and volatile international crude oil prices and continuing firmness in key food prices.

Although inflation had eased since the end of March, inflationary pressures still lurked in the economy.

It said that in addition to the hardening of international commodity prices, in particular oil prices, there could be inflationary pressures from domestic factors such as elevated asset prices and large capital inflows which could have implications on domestic liquidity conditions.

“Accordingly, a continuous vigil supported by appropriate policy actions by all concerned would be needed to maintain price stability so as to anchor inflationary expectations on a sustained basis,” the report said.

For the first time since the sub-prime mortgage crisis broke out in the US, the RBI said risks emanating from a housing slowdown and potential shifts in financial market sentiment posed a downward risk to global growth prospects. Significantly, if these risks materialise, it could have some adverse impact on the domestic economy.

The central bank said if the US economy experienced a sharper slowdown because of a broader-than-expected impact of housing sector difficulties, spillover effects into other economies would be larger and de-coupling from the US economy would be more difficult. In addition, there could be an impact in the financial markets as well.

“Further deterioration in sub-prime delinquencies could lead to reassessment of risk by investors across products and markets and retrenchment of capital from the emerging market economies (EMEs), given the contagion and herd mentality,” the report warned.

According to the RBI, volatility in capital flows could be exacerbated by the growing dominance of players such as hedge funds even as private equity funds have emerged as a key source of capital flows to EMEs.

Any monetary tightening by authorities in major economies could impact growth and stability in the EMEs as it could increase volatility in the global financial markets with hedge funds and others pulling out.