The Reserve Bank of India will step in to soothe local currency and money markets if a war breaks out in Iraq, a senior banking official told Reuters on Monday.

"The Reserve Bank of India will make sure that there is no undue volatility in either the currency or the bond market," the official said on condition of anonymity.

The official declined to elaborate, but the RBI has in the past sold dollars to prevent a sharp slide in the rupee and bought bonds to inject cash in the wake of adverse international developments.

Indian markets were jittery in morning trade after United States President George W Bush said that Monday was the last day for diplomacy to find a solution to Iraq.

His comments drove up prices of oil, India's largest import item, and pushed Indian bond yields and rupee-dollar forwards which are used by importers to hedge payables higher.

Central bank Governor Bimal Jalan told reporters on the weekend that the Indian economy was strong enough to withstand any adverse external developments, but most traders said they would remain cautious ahead of a war.

Jalan said the average rate of inflation was satisfactory despite the worst drought in 15 years and an increase in oil prices.

Analysts said India's forex reserves of more than $73 billion, sufficient to pay for more than a year's imports, could cushion a short-term jump in oil prices.

India buys 70 per cent of its crude oil needs or 1.7 million barrels a day. Every dollar rise in crude prices inflates the oil import bill by $620 million a year and increases the wholesale price index by half a point, economists say.

India's oil import bill stood at $14.35 billion during April to January in the current year against $13.5 billion in the previous year ended March.