This implies that the current account deficit could head to a region of 3.8-4% of GDP. Incidentally, from FY06, the current account deficit had been widening due to Indias strong growth. In FY06, it was at 1.1% and increased in the last FY to 2.9%. But this was backed by healthy capital inflows, at 3.1% of GDP in FY06 and 9.2% in FY08. As capital inflows continued to override the current account deficit, the importance of trade and current account deficits were forgotten.
The dynamics of the global financial markets remain relevant for the capital and current account interplay, given the adequate proof from October 2008 that India is strongly meshed into the global financial system. The worst fears of a total financial meltdown in Europe are now on the back burner with the implementation of the bailout packages and with the bank stress test results not as bad as was being expected. However, in my opinion the risks have just been pushed out onto a future date. With fiscal consolidation being the precondition for availing financial packages, the austerity measures of the European countries are likely to undermine the consumption power of these economies. This is likely to exert a downward pressure on tax revenues, thereby needing further austerity to achieve the laid-out targets.
Thus, expectations remain strong that the Eurozone, which has been witnessing better economic news, would again slump back into a slowdown mode. Even the economic news out of the US has not been too good at the moment. Key housing related data has been slumping, unemployment levels remain high, and confidence indicators along with other lead economic indicators have been wilting. This has led to the Fed chairman pointing out to an unusually uncertain atmosphere for the US economy, restoring the size of the quantitative easing and hence pushing back the chances of any rise in the US benchmark policy interest as a distant aspiration. With all this, the probability of a global double-dip recession is on the rise and one remains unsure of the extent of damage that the banking system in the US and Europe would have to endure this time around. More crucially, all this could once again culminate in an extended zone of risk-aversion, a fall in the global equity markets and a consequent outflows from India as well.
The arguments make it clear that my bias is only for rupee depreciation, a view that I have held long and even in a situation when the rupee had appreciated close to 44 to a dollar. Not too long back, most expectations were for the rupee to appreciate to around 42 to a dollar and such expectations should be tempered. There could be momentary appreciations though based on either the global risk-on/risk-off atmosphere and also due to some lumpy forex flows into India on the back of probable PSU disinvestments. But the more crucial fallout of the reduction of the gap between the current account deficit and the capital account surplus will be on domestic liquidity. This is because there is not enough of foreign currency surplus in the market for RBI to sterilise, a source of rupee liquidity.
The above changing dynamics imply that a continuation of the upward momentum of Indias GDP cant be taken for granted. Liquidity has currently been kept on a tight leash by RBI to ensure that the transmission of monetary policy changes happens efficiently so that inflationary expectations are contained. However, if a scenario of global risk-aversion were to play itself out once again, leading to some outflows through the forex route, there may not be enough domestic resources (such as MSS) that can be unlocked. In this scenario, we might once again see the CRR being reduced to generate liquidity for growth, earlier than anyone could have expected.
The author is chief economist, Kotak Mahindra Bank. Views are personal