Centre may eye FDI to finance high CAD

High volatility in foreign institutional investors' flows underscore challenges in financing the gap

To finance its high current account deficit (CAD), the government might consider attracting more foreign direct investment (FDI) into the country.

For the quarter ended December, the CAD had touched a record high of 6.7 per cent of gross domestic product, against 5.4 per cent in the previous quarter.

In its monetary policy statement today, RBI said, "The main challenge is to reduce the CAD to a sustainable level; the near-term challenge is to finance it through stable flows." Of late, foreign institutional investors (FIIs) have been pulling out of domestic markets and the Street views this as a concern. "When we are running a high CAD, it will be a challenge to finance it, as we are at the mercy of global risk appetite. Unless CAD comes down substantially, financing it will be a challenge," said A Prasanna, chief economist, ICICI Securities Primary Dealership.

Data from the Securities and Exchange Board of India shows so far this month, FIIs have pulled out $3,825.71 million from domestic markets. "Financing CAD is a challenge, but FIIs are not the only source of funding CAD. We have other capital flows, NRI (non-resident Indian) deposits and upfront measures, which may prompt the government to open up more FDI," said Shubhada Rao, chief economist, YES Bank.

Economists say the pull-out of FII investments was triggered by expectations that the US Federal Reserve would taper the third round of quantitative easing this year. Radhika Rao, economist, DBS Bank, however, said the sell-off might not be sustained, as the market was awaiting clarity from the US Federal Reserve at the two-day Federal Open Market Committee meeting, which concludes on Wednesday. "We expect the Fed to sound cautious on growth prospects. We believe FII flows into equity and debt will continue in India, as the rate cut has been delayed for now and the rate differentials remain attractive," Rao said.