Although India’s medium-term growth prospects remain intact, its external environment calls for a critical watch, for its current account deficit has widened to a record $15.8 bn for July-September quarter, from a level of $12.1 bn during April-June quarter, which looks disturbing when compared to $9.2 bn that was recorded for July-September quarter of 2009. With exports getting hit by the dampened external demand conditions, the robust domestic growth has obviously led to increased imports—excess of imports over exports was higher at $35.4 bn in July-September against $29.6 bn a year ago—resulting in the widening current account deficit.
It is, of course, good that India, unlike other Asian economies that are growing by subsidizing their export sector, is reaping the benefit of free trade for the good of its teeming population. Yet, one cannot be comfortable with 88% of the total capital of $21.7 bn that has flown into the country confining to stock markets and bonds alone. Obviously, the Reserve Bank of India is worried about such flows, for they are pretty volatile in nature.
Looking at the meager inflow of $2.5 bn as foreign direct investment against $10 bn during April-June quarter of 2008—which otherwise means that the current account deficit is being increasingly financed by short-term capital that has in the recent past zoomed to $66 bn at the end of September quarter—the present current account deficit deserves to be looked at as a downside risk for the economy.
And the ongoing easy money policy of the US Federal Reserve is all set to aggravate the situation further. Having recovered from the financial crisis-led slowdown much faster than the developed countries, as India moved on to policy-tightening measures, interest rate differential vis-à-vis developed countries has widened. The annualized yield on a three-month rupee deposit is the highest among various currencies, standing at around 8% as of December 2010. Such a high interest rate differential is sure to attract further capital inflows, particularly when capital is available in the western countries at near zero interest rates. Although increased foreign capital inflows are being absorbed through a higher current account deficit containing the impact of surplus capital flows on the exchange rate, continued positive inflation rate differential is sure to weaken the competitiveness of our exports.
Against this backdrop, the poor inflow under FDI is a matter of concern for us—more than a mere concern, it calls for a thorough analysis of the market mechanics that led to the current situation and a constant assessment of the developments in the global currency markets and their impact on Indian economy. There is an apprehension in the market that rules and regulations governing investment under FDI are not that simple as in the case of capital flows into stock markets, nor are they that transparent. True, each sector has its own labyrinthine set of regulations that daunt even a seasoned businessman to venture into greenfield projects in India. There are many such instances where foreign companies like Korean steel giant—Posco—are waiting for political clearance for establishing its $12 bn project in Orissa.
Although India’s medium-term growth prospects remain intact, its external environment calls for a critical watch, for its current account deficit has widened to a record $15.8 bn for July-September quarter, from a level of $12.1 bn during April-June quarter, which looks disturbing when compared to $9.2 bn that was recorded for July-September quarter of 2009. With exports getting hit by the dampened external demand conditions, the robust domestic growth has obviously led to increased imports—excess of imports over exports was higher at $35.4 bn in July-September against $29.6 bn a year ago—resulting in the widening current account deficit.
It is, of course, good that India, unlike other Asian economies that are growing by subsidizing their export sector, is reaping the benefit of free trade for the good of its teeming population. Yet, one cannot be comfortable with 88% of the total capital of $21.7 bn that has flown into the country confining to stock markets and bonds alone. Obviously, the Reserve Bank of India is worried about such flows, for they are pretty volatile in nature.
Looking at the meager inflow of $2.5 bn as foreign direct investment against $10 bn during April-June quarter of 2008—which otherwise means that the current account deficit is being increasingly financed by short-term capital that has in the recent past zoomed to $66 bn at the end of September quarter—the present current account deficit deserves to be looked at as a downside risk for the economy.
And the ongoing easy money policy of the US Federal Reserve is all set to aggravate the situation further. Having recovered from the financial crisis-led slowdown much faster than the developed countries, as India moved on to policy-tightening measures, interest rate differential vis-à-vis developed countries has widened. The annualized yield on a three-month rupee deposit is the highest among various currencies, standing at around 8% as of December 2010. Such a high interest rate differential is sure to attract further capital inflows, particularly when capital is available in the western countries at near zero interest rates. Although increased foreign capital inflows are being absorbed through a higher current account deficit containing the impact of surplus capital flows on the exchange rate, continued positive inflation rate differential is sure to weaken the competitiveness of our exports.
Against this backdrop, the poor inflow under FDI is a matter of concern for us—more than a mere concern, it calls for a thorough analysis of the market mechanics that led to the current situation and a constant assessment of the developments in the global currency markets and their impact on Indian economy. There is an apprehension in the market that rules and regulations governing investment under FDI are not that simple as in the case of capital flows into stock markets, nor are they that transparent. True, each sector has its own labyrinthine set of regulations that daunt even a seasoned businessman to venture into greenfield projects in India. There are many such instances where foreign companies like Korean steel giant—Posco—are waiting for political clearance for establishing its $12 bn project in Orissa.
Evidently, the challenge of managing capital flows and absorbing them with least disturbance calls for a wide range of policy changes that can project India as a country with long-term growth potential rather than a mere investment opportunity to make a quick buck. Fortunately, when the economy is in an upbeat mood, it is that much easier to launch reforms such as cutting down fiscal deficit while simultaneously providing safety-net for the vulnerable sections of the society, developing corporate bond market, mitigating corruption and bureaucratic red tape, and simply making investors’ transactions with India easy and transparent.
- GRK Murty
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