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External sector indicators improved, but no room for complacency: RBI

Easing of gold import norms could led to widening of current account deficit, says HR Khan

BS Reporter Mumbai
While acknowledging that India’s external sector indicators have improved in the first six months of FY15, the Reserve Bank of India (RBI) has cautioned there is no room for complacency in an uncertain global macroeconomic environment.

According to RBI, India’s import cover rose to 8.1 months as of September 2014 from 6.6 months at the end of September 2013 and the ratio of current account deficit (CAD) to foreign exchange reserves improved from 30.1 in 2012-13 to 10.6 in 2013-14.

Between April and September 2014, India’s total foreign reserves increased by $11 billion, which is now at an all-time high of $333 billion.
 

“Lower CAD, surge in foreign exchange reserves and exchange rate stability are signs of a more resilient external sector. Improvements in external sector indicators, however, do not warrant any policy complacency,” said H R Khan, deputy governor of RBI, at a speech in Pune on Monday. The speech, delivered at a management institute, was released by RBI on Tuesday.

“Spillovers from renewed external pressures through the seven channels mentioned earlier may resurface and thus pose a challenge for India’s external sector,” said Khan.

Commenting that foreign exchange reserve forms the first line of defence to calm volatility in the forex markets and provide adequate liquidity for a sudden stop or reversal in the capital flows, Khan warned that accumulating reserves comes at a cost.

“We should also remember that holding reserves has a cost. This cost has a quasi-fiscal implication as the cost of sterilisation is either borne by the government or by the central bank itself,” he added.

The deputy governor highlighted several risks that could pose a challenge to the external sector.

One of the risks to the external sector stability could emanate from likely interest rate hike by the US Federal Reserve when global liquidity will reverse their flows from emerging markets.

“China’s exchange rate policy in the context of ongoing slowdown also presents an external risk to Asian currencies including the rupee,” he said, citing another potential risk.

Khan also cautioned against higher non-oil non-gold imports as domestic investment cycle picks up with the economic revival.

“Easing of norms for gold imports could lead to widening of CAD in 2014-15,” he added. The government has recently scrapped the 80:20 norm for gold imports.

The other area of risk could come from global crude prices despite those are projected to stay low as price war intensifies.

“Even though international crude oil prices are projected to stay low as price war intensifies, the re-emergence of geopolitical risks, particularly in Middle-East and Ukraine, may keep oil prices relatively firm and thus may have implications for India’s oil import bill. This may pose upward risks to India’s CAD,” said Khan.

The central bank noted that while the drop in prices was over 50 per cent since mid-2014, recent weeks have seen an uptick in prices. “The up move of about 20 per cent has also been somewhat unexpected at a time when many analysts were expecting oil prices to fall further,” Khan added.

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First Published: Feb 25 2015 | 12:29 AM IST

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