Cautioning that high current account deficit cannot be sustained in the long run, the Reserve Bank of India (RBI) today said it would monitor closely the external sector as well as the global developments.
India's current account deficit (CAD), representing the difference of inflows and outflows of foreign exchange barring capital movements, surged 72 per cent to $15.8 billion in the July-September quarter over $9.2 billion in the same period last year due to higher imports.
"...The external sector needs to be monitored closely. The economy is very well poised to absorb a higher current account deficit for a couple of years but this cannot remain a persisting trend," the RBI said in its macroeconomic review released today.
The RBI said that the widening of CAD is a result of factors like lower growth in services receipts reflecting uneven pace of global recovery; significant rise in imports relative to exports reflecting steep rise in international crude oil prices, moderation in FDI inflows reportedly because of environment sensitive policies, land acquisition issues and availability of quality infrastructure.
It added that although larger net capital inflows were absorbed in financing the higher current account deficit, the composition of capital flows poses sustainability risks.
Higher capital inflows were due to higher investment in capital markets by foreign funds, external commercial borrowings by India Inc and external assistance.
While buoyancy in capital inflows continued during Q2 of 2010-11, driven by large inflows under FII investments, FDI moderated mainly on account of lower inflows under real estate, construction, and financial services, it said.
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"The shift in the composition of capital flows, particularly the sharp jump in portfolio inflows and significant decline in net FDI inflows, however, raise questions about the sustainability of the external sector in the medium-term," the RBI said.
The CAD, which includes deficit in external trade of goods, services, besides net investment income, stood at 2.9 per cent of GDP last fiscal, and experts believe that it will increase a bit to 3 per cent of GDP this fiscal.
Further, during July-September quarter, FIIs put in $18.8 billion, while it was only $7 billion in the same period last fiscal. However, FDI fell to $2.5 billion from $7.5 billion in the year-ago period.
CAD climbed because imports rose to $177.5 billion against $138.4 billion a year ago, as economy was on the uptick, reverting to high 8.9 per cent growth in the second quarter of this fiscal.
"The prospects for the medium-term adjustment will improve with the global recovery consolidating, FDI flows to India strengthening on the promise of growth prospects and the reform process being accelerated," the RBI said.