Indian shares, which tumbled more than 3 percent in early trade as a rating downgrade of the United States by Standard & Poor's triggered panic selling across Asian equity markets, recovered to end the day 1.82 percent lower.
Earlier, India's central bank said in a statement it was monitoring the global situation and would "respond quickly and appropriately to the evolving situation".
The Reserve Bank of India (RBI) said the Indian banking system does not face any immediate liquidity stress, and it vowed to ensure adequate rupee and forex liquidity.
Similar assurances came from Finance Minister Pranab Mukherjee, who said India's economic growth and strong fundamentals make it better placed than other economies to tackle the uncertainty in global markets.
"There could be some impact on the capital and trade flows. But as India's growth story is strong, we could see FIIs (foreign institutional investors) seeing India as an attractive investment destination even if there is any temporary outflow," Mukherjee said, citing higher returns offered by the country.
"(We are) ready to take action to ensure financial stability and liquidity in financial markets."
Mukherjee also said the government would speed up policy reforms to make India an attractive investment destination. His comments helped India's main stock index trim losses.
US investment bank Goldman Sachs on Monday upgraded India to "market weight" from "underweight," given a likely turn in the macro cycle, lower oil prices, lower valuation, and policy reform.
INFLATION OUTLOOK
Riding on its robust domestic demand, India managed to withstand the global financial crisis in 2008/09, clocking an economic growth of 6.8 percent.
Worries over the health of the global economy are clouding the export outlook for Asia's third-largest economy -- after recent double-digit export growth -- but are also helping moderate global commodity prices, particularly oil.
Oil fell as much as $3 a barrel on Monday as worries over a possible double-dip recession spread after S&P cut the United States' top-tier credit rating and European central banks struggled to contain a deepening debt crisis.
A moderation in global oil prices is expected to help rein in India's oil subsidy bill, or the cash compensation the government offers to state-run firms for cheaper fuel sales, and ease inflationary woes.
"It (the fall in international crude and commodity prices) can have a dampening effect on Indian inflation," said Kaushik Basu, chief economic adviser to the finance ministry.
India has been struggling with high inflation for the past two years. The RBI has raised interest rates 11 times since mid-March 2010 to tame price pressures, but headline inflation of 9.44 percent in June continues to be well above the central bank's comfort zone of 4-4.5 percent.
Policymakers globally intensified efforts to contain the fallout from the historic downgrade of the US debt rating.
"I can take the rating as a special event which is telling us that a double-dip recession will occur ... that is possible," Basu said.
The European Central Bank stepped into bond markets on Monday, backing up a pledge to support Spain and Italy with the aim of averting financial meltdown in the euro zone, while the G7 and G20 offered soothing words to investors shaken by a historic downgrade of the US debt rating.
Copyright Reuters, 2011