Policymakers are now more optimistic of the economy?s capacity to absorb capital inflows without having to resort to artificial controls. The government, together with the Reserve Bank of India (RBI), have discussed the matter and have come to an understanding that given the import-intensity of the fast-growing economy, the tolerable level of net capital inflows could be informally set at $150 billion, up from the earlier figure of around $110 billion.
The Centre and RBI reckon that due to strong domestic growth and limited export growth, more external capital would be needed to finance the current account deficit, (CAD) which is estimated at close to 3% of GDP for 2010-11.
CAD, the difference between export and imports, plus remittances and net invisible, is financed through surplus capital account (or net capital inflows), which include foreign direct investment, portfolio investment, banking capital and external loans. The country?s absorption capacity, as reflected by CAD, has gone up more than four times between 2007-08 and 2009-10, according to RBI data. During this period, CAD had increased from 1% of GDP ($9 billion) to 2.9% ($40 billion). This gives authorities the leeway to tolerate higher capital inflows.
The Prime Minister?s Economic Advisory Council estimates that the country will attract net capital inflows of $73 billion in the current fiscal, which, it thinks, is manageable. The amount is projected to rise to $91 billion in 2011-12. The council has stated that these capital flows can be readily absorbed by the need for financing the economy?s high growth.
However, the council?s head, C Rangarajan, has voiced the need to tweak trade policy in order to rein in CAD.
This is significant, since it indicates tolerance for higher inflows, even though RBI continues to monitor volatility. This was evident in RBI?s review of the monetary policy on July 27. According to a Standard Chartered Bank research note, ?risks to liquidity from a surge in capital flows also seem to be limited, since RBI expects a major proportion of capital flows be absorbed by a wider current account deficit. This is in contrast with the concern raised until April?s policy meeting that a potential surge in capital flows would significantly increase liquidity.?
In 2007-08, the government had to put in place a series of capital controls, including a ban on participatory notes and restrictions on external debt, in order to stem the tide of inflows that pushed up asset prices and resulted in runaway currency appreciation. Officials feel that currently, the chances of excessive capital inflows necessitating controls look remote.
