In its 2003-04 annual report released to the media on Monday, the Reserve Bank of India (RBI) said outlook on the economy continues to be bright due to possible acceleration of world output and enhanced domestic activities.

But the downward risks emanating from uncertain monsoon as well as the possible persistence of high and uncertain oil prices would impart an element of downward bias to the expected GDP growth estimated at the beginning of the year, said the report.

In its credit policy announced in May this year, RBI had forecast GDP growth at 6.5 percent and average inflation at five percent for fiscal 2004-05 but in the annual report there was not forecast in the case of GDP growth.

The central bank hopes that India, in any case, would remain among the top performers.

Referring to interest rates, it said domestic rates were likely to be impacted with the northward movement of international interest rates and financial markets would have to manage these challenges.

With the return of inflation worldwide and raising of policy rates by central banks in several countries, reversal of existing ample international liquidity conditions would impact domestic financial markets, the RBI warned.

On inflation, which reached almost eight percent in mid-August, the RBI said oil prices and progress of southwest monsoon hold the key to overall inflationary pressure outlook for 2004-05 financial year.

Uneven distribution of rainfall in various parts of India has evoked some concern over the possible impact on primary agricultural commodities prices but signs of revival of monsoon in the beginning of August could somewhat dampen the adverse effect, it said.

In any case, food stocks and foreign exchange reserves should provide a cushion against any pressure on food prices, the report said.

On the assumption of no significant supply shocks and appropriate management of liquidity, the RBI annual report projects the inflation to be at five percent during 2004-05. It said there is increasing sensitivity of domestic inflation to the movement of international commodity prices with the opening up of the Indian economy.

The bank said the prime objective of its monetary policy remains price stability. The policy would also pursue an interest rate environment conducive to maintaining growth, it added.

On agriculture sector, the report suggested that to record higher growth the financial sector needs to focus on extending the cover of insurance against crop losses, development of commodity market to minimise the impact of price uncertainties and creation of facilities to meet all the needs of rural economy.

It said India's external sector would benefit from prospects of strengthening of world economy and trade in 2004. By current reckoning, India has entered a phase of durable current account surpluses in balance of payments even after accounting for any acceleration in imports resulting from positive macro-economic outlook.