Central bank governor Yaga Venugopal Reddy said in a speech released in Mumbai for delivery in Paris that government borrowing costs could rise if external factors pushed up domestic interest rates.

But because most government borrowing was at fixed rates the rise would be "incremental" providing "greater headroom for a flexible monetary policy to adjust policy rates, as and when warranted, without any excessive impact on the fiscal deficit."

Reddy said the outlook for output growth in India had improved in recent months, particularly with momentum gained in manufacturing.

"However, persistence of global imbalances and high oil prices with a significant permanent component do pose some risks," he said.

Speaking about the implications of global financial imbalances for emerging markets, Reddy said while India by itself hardly contributed to global financial imbalances, big changes in external conditions could indirectly impact the Indian economy.

"It is clear that the impact on India would depend on the pace and extent of currency and current account readjustments, and changes in global interest rates," he said.

Apart from government borrowing, Indian corporates could be affected by deterioration in financing conditions if they had not hedged foreign exchange positions on overseas borrowings.

Indian corporates have been borrowing extensively over the past two years from international markets to fuel their expansion and take advantage of low foreign interest rates.