The World Bank estimate for India?s current account deficit (CAD) this year is a high 2.9% of the GDP, almost double the current figure. So CAD in nominal terms may go up to $30 billion. Will financing it be a problem? Net capital inflows into India were about $83 billion in the first three quarters of the last fiscal year. But this year, portfolio investment has been more out than in. FDI inflows can increase if there?s policy clarity and reform in some key sectors. But can that clarity or reform be expected from the UPA government at this stage? Or maybe CAD imperatives will produce some policy change. An increasing CAD will contribute to a growing demand for dollars and add to depreciation pressures on the rupee or at least restrain it from appreciating. RBI has been fighting to keep the rupee from appreciating and in the process, complicating its fight against inflation. Maybe rising CAD will help it focus more sharply on just inflation, although the time for really effective intervention was earlier. The impact of a rising CAD on rupee exchange rates will be severe for two more reasons. One, America?s CAD, which dropped from 6.2% of the GDP in 2006 to 5.4% in 2007, is expected to further decline to 5.1% by 2010. This will act as a buffer against further strengthening of the dollar. Second, most emerging market economies running current account surpluses?China, Indonesia, Philippines, Thailand are the usual examples?are expected to feel a pinch on their current account in 2009. This will tend to soften their currencies vis-?-vis the dollar.
A growing CAD is popularly interpreted as an unpropitious economic sign?a country consumes more than it produces and finances the additional consumption through debt or sale of assets to foreigners. But this is true only if financing the deficit is a big problem and CAD can also be a positive sign of hectic investment activity. The US, for example, runs a huge CAD financed by foreign inflows. In India?s case, the question, as discussed above, is whether an increasing CAD can be financed through FDI and FII. Debt-creating flows are another option. It is good to remember that short-term debt has increased its weight in India?s foreign debt basket. Those worried about excessive capital inflows earlier must reverse their prayers.
