Even at $100 bn, FDI may not be sufficient to finance ballooning CAD

CAD is expected to hit a decadal high of 3.8% of GDP, or $130.5 bn; to make matters worse, FDI inflows expected are on gross basis and net inflows would be much lower than $100 bn

The government is confident that the country is on track to attract foreign direct investment (FDI) of $100 billion in the current financial year. If that happens, the country will get some relief amid uncertain foreign portfolio investments (FPI) flows in financing its burgeoning current account deficit (CAD), which is expected to be at a decadal high of about 3.8 per cent of gross domestic product (GDP) this fiscal.

However, this along with other external investments flow, is not likely to be sufficient to fully finance CAD.

A CAD as high as 3.8 per cent of GDP means $130.5 billion for FY'Y23, according to a note by Motilal Oswal Financial Services Ltd (MOFSL).

Here it should also be noted that the government talked about $100 billion FDI in gross terms. For financing CAD, the net FDI is important. This figure is not known now, but it would definitely be much lower than the gross amount. For instance, gross FDI of $83.6 billion came in during 2021-22, but net FDI was just 39.3 billion.

However, CAD was just 1.2 per cent of GDP or $38.7 billion in FY22. So, despite FPI taking out $16.8 billion there was a net accretion of $47.5 billion in foreign exchange reserves due to FDI along with external commercial borrowings, NRI deposits etc.

Even if net FDI flow turns out to be $47 billion in the current financial year (assuming it to be in the same proportion of gross FDI as was in FY22), financing CAD of $130.5 billion would be an uphill task.

This would also be due to the fact that $5.5 billion worth of stocks and debt have so far been sold out by FPIs on a net basis till September 26. FPI flows have been very volatile and hence it is very difficult to estimate them for the current financial year. For instance, FPIs were net buyers of $1.4 billion till September 26 despite selling off in the last three days. The situation would remain uncertain till geopolitical tensions around Russia-Ukraine war ease.

In a nutshell, robust FDI inflows would help ease some pressure in financing CAD but it would not be sufficient to finance it totally. Hence there would be some withdrawal of forex reserves in FY23.

Financial advisory firm Motilal Oswal Financial Services Ltd (MOFSL) estimated that forex reserves are likely to reduce by $77 billion in the year. As of September two this year, the RBI’s holding of forex reserves has already dropped to $553 billion, which is expected to decline by another $23 billion during FY23, said MOFSL.

At $530 billion, forex reserves would be sufficient to provide import cover for around eight months in the current financial year which is way down from around 12 months in FY22. It was way back in 2013-14 when forex cover was sufficient to provide import cover for about eight months.