India has traditionally been a current account-deficit economy, and has been financed by capital account surplus.
The current financial year may alter the norm. Chances are that the capital account will face strain due to volatile equity markets, drying up funds abroad as a fallout of a general global economic slowdown. Some economists even say it will be a challenge for capital account to remain positive in the current fiscal.
True, the capital account was quite robust in the first quarter of this fiscal, when it showed a seven-month-high surplus of over $20 billion. But the profile looks headed for a change.
“For the capital account to remain positive seems like a big challenge to me at the moment,” says Anis Chakravarty, director, Deloitte, Haskins and Sells.
Cut to 2008-09. That year saw two quarters of deficit amid a global financial crisis, yet the capital account was still in surplus for the entire fiscal. In fact, it ended up in a surplus of $8.7 billion, albeit quite down from a whopping $108 billion in 2007-08.
As of now, the current account deficit stood at over $14 billion, or 3.14 per cent, of the GDP. In absolute number, the country’s deficit is more or less same as was in the October-December period of 2008-09, when India too felt the impact of global financial crisis.
In the first eight months of this fiscal, the trade deficit (difference between merchandise imports and exports) stood at a staggering $106.9 billion. This will put further pressure on the current account deficit. However, generally, a surplus in services trade is more than the trade deficit, thus bringing pressure down on the current account deficit.
If the capital account also turns deficit this fiscal along with current account, forex reserves will face a hit. It already stood at nine-month low of $302.1 billion for the week ended December 16.
Says Arun Singh, senior economist at Dun and Bradstreet: “The depreciation of rupee, slowdown in the domestic economy, the domestic and global sentiment will together put a strain on the capital account balance.”
FDI, a component of capital account balance, saw a 50 per cent decline on a year-on-year basis in October. The FDI was down to $1.16 billion compared to $2.33 billion last year. In September, the inflows were at $1.76 billion — down by 16.5% year-on-year basis.
For the first seven months in this fiscal, the FDI inflows rose to $20.29 billion against $12.39 billion in the corresponding period of 2010-11.
“Going by the current political scenario it will not be easy for FDI to come into India,” says Siddharth Shankar, director, KASSA. “Liquidity still remains an issue in Europe, same goes with China. The only country from where FDI can will be US.”
FII net inflows, on the other hand, stood at just $176.92 million in equity markets till December 26. However, their net investment in debt markets have been $6.20 billion during the same period. Notes Deloitte’s Chakravarty: “We will need a certain FII turnaround for the capital account to recover.”
Prime Minister’s Economic Advisory Council (PMEAC), however, says that capital flows will increase in the Jan-March quarter. Reason: foreign investors allocate funds for each country in the New Year. “India being one of the fastest growing economies with a 7-7.25 per cent growth rate, foreign investors will allocate more funds,” points out C Rangarajan, the council’s chairman.
The PMEAC has pegged CAD at 2.7 per cent of the GDP this fiscal. However, Rangarajan says CAD may be higher than his council’s projection of 2.7 per cent of the GDP. “But not very much high,” he adds.
Chakravarty, however, has doubts on that front, given the problems in Euro and US.
Even on the domestic front, things are not looking up. This may not send very positive signals to foreign investors. “Since 1991,” notes Singh, “we haven’t seen big reforms that could boost investors’ sentiment.”
Madan Sabnavis, chief economist, CARE Ratings says the RBI’s measures to increase NRI flow can draw more funds from abroad.
