Three strategies to cushion R against large capital outgo

Written by fe Bureau | New Delhi | Updated: Mar 16 2012, 09:31am hrs
The government may adopt a three-pronged strategy to cushion the rupee against the potential impact of large-scale capital outflows. This includes curbs on imports of unproductive products like gold and consumer items, easier FDI policy, and an enhanced focus on exports.

The government's new thinking is apparently sparked by realisation that the existing policy of using foreign investment inflows to finance current account deficit (CAD) is not a great idea. The country's CAD in the current fiscal is estimated to hit 3.6%, up from 2.8% from the previous year, on the back of a high trade deficit.

Trade deficit in the current year is estimated to hit 15% of the GDP as exports falter while imports remain high. In comparison, the trade deficit in the past year was estimated at 8.9% of the GDP. The outlook for the coming year is also grim given eurozone woes.

The rupee came under unprecedented pressure during December when FIIs fled the market and investment from domestic investors dropped sharply.

Industry experts agree that rupee remains vulnerable to volatility as capital flows are likely to change because of the fragile condition of the world economy. However, they remain sceptical about the effectiveness of these identified measures.

The rupee will remain vulnerable to volatility given India's high CAD, said DK Joshi, chief economist, Crisil. It is a very volatile situation, concurred Abheek Baruah, chief economist, HDFC Bank.

Imports will grow if the rupee depreciates, cautioned Anil Bhardwaj, director general of trade body Fisme.

However, measures identified by the government to check the rupee might be difficult to implement.

Hiking import duty on gold might encourage smuggling and create a black market for the yellow metal, Bhardwaj said. Joshi warned against reading too much into these policy measures, saying, This is the government's wish list.

HDFC's chief economist wants the government to focus on fiscal consolidation. If you bring down fiscal deficit, CAD will come down, Barua said.

FDI inflows were estimated at $35.3 billion during April-December 2011, compared with $16.0 billion in the corresponding period of the preceding year. Portfolio inflows fell sharply to $3.3 billion from $31.3 billion a year earlier, reflecting uncertainty and risk in the global economy on account of the eurozone crisis.

Capital account surplus was estimated at $41 billion during the first half of the current fiscal, against $39 billion during the same period of the preceding year.

India's external debt stock increased by 6.6% to $326.6 billion during the first half of the current fiscal. This increase was primarily on account of higher commercial borrowings and short-term debt. The rise in short-term trade credits is in line with the increase in imports associated with reasonably strong domestic economic activity.

Long-term external debt, which stood at $255.1 billion as on September end, accounted for 78.1% of total external debt. Long-term debt grew by $13.6 billion, or 5.6%, during the first half of the current fiscal while short-term debt (original maturity) registered an increase of $ 6.5 billion, or 10.1%.

As on December end, forex reserves stood at $296.7 billion, indicating a decline of $8.1 billion from $304.8 billion as of March 2011 end. This level of reserves provides about eight months of import cover.