Saying there existed limited room for the monetary policy to manage external sector risks, the Reserve Bank of India (RBI) on Monday favoured a hike in petroleum product prices and steps to curb demand for precious metals to arrest a widening current account deficit (CAD).
Further reforms in policies are a must to attract more foreign direct investment (FDI) or equity in the country, the central bank said in its Macroeconomic and Monetary Developments report released ahead of its annual policy for 2012-13.
RBI said the monetary policy would need to support growth without risking external balance or inflation by excessively fuelling demand.
While capital inflows have improved in Q4 of 2011-12, global uncertainties aggravate downside risks to the external outlook. Dependence on debt-creating capital inflows needs to be reduced by encouraging renewed equity flows through accelerated reforms to attract FDI.
It now requires greater prudence in the external sector owing to wider current account deficit, rising external debt and weakening net international investment position. For the record, India's current account deficit shot up to 4.3 per cent of the gross domestic product for the third quarter ended December 2011 from 2.3 per cent for Q3 in 2010. The trade deficit for the October-December 2011 widened to $47.7 billion from $ 31.4 billion in Q3 last year.
Given the grim economic and business climate abroad, RBI said there was less prospect of improvement in external trade. Export growth may weaken as growth in emerging and developing economies slows down.
The import bill will remain high unless prices of petroleum products are raised for a complete pass-through and demand for precious metals is curbed.
The balance of payments came under stress during Q3 of 2011-12 due to deterioration of the trade balance and moderation in capital inflows. This was despite the depreciation of the rupee in the quarter. The inelastic nature of some imports and a slowdown in exports reflected global uncertainty.
RBI said the full year CAD for 2011-12 was likely to be substantial. The CAD might still remain under pressure if import of oil and gold does not significantly moderate. Robust gold demand and continuing high crude oil prices, along with decelerating growth in EDEs might adversely affect India's trade balance.
India's external debt increased to $335 billion at end-December 2011 from $324 billion at end-September 2011 largely reflecting a sharp increase in ECB and short-term debt.
Keeping in view the developments in international financial markets and global economic conditions, RBI enhanced the all-in-cost ceiling on ECBs and deregulated interest rates on NRI deposits.
The full-year external debt is likely to be higher reflecting greater reliance on debt flows to finance CAD. Nonetheless, it is expected that external debt will remain at a manageable level.
The key external sector vulnerability indicators worsened in Q3 of 2011-12. The reserve cover of imports and the debt service ratio deteriorated during the quarter. India's net international investment position also weakened as net liabilities increased to $216 billion at end-December.
