Financing higher CAD may prompt govt for more FDI

In mid-quarter review of monetary policy, RBI again flagged concerns on high CAD

Financing the high Current Account Deficit (CAD) may prompt the government to open up more Foreign Direct Investments (FDI). In the mid-quarter review of the monetary policy the Reserve Bank of India (RBI) again flagged concerns on the high CAD.

CAD is the difference between inflows and outflows of foreign exchange into the country. The CAD had touched a record high of 6.7% of the Gross Domestic Product (GDP) from 5.4% of GDP the previous quarter.

On Monday RBI said in its monetary policy statement that “the main challenge is to reduce the CAD to a sustainable level; the near-term challenge is to finance it through stable flows”. Off late Foreign Institutional Investors (FIIs) have been pulling out of domestic markets and that is seen as a concern by the street.

“When we are running a high CAD, it will be a challenge to finance it as we are the mercy of global risk appetite. Unless the CAD comes down substantially, financing it will be a challenge,” said A Prasanna, chief economist,  ICICI Securities Primary Dealership.

Data from Securities and Exchange Board of India (Sebi) shows that FIIs pulled out $ 3226.67 million in June so far from domestic markets. According to experts in a situation when FII inflows are drying out a higher CAD will spurt the government into action to open up more FDI.

“Financing the CAD is a challenge but FIIs are not the only source of funding the CAD. We have other capital flows, NRI deposits, upfront measures which may be prompted by government to open up more FDI,” said Shubhada Rao, chief economist, YES Bank.

According to economists the pull out of FII investments was triggered by expectations of US Fed tapering the third round of quantitative easing (QE3) in 2013. However, according to Radhika Rao, economist, DBS Bank this sell off may not be sustained as the market is now waiting for more clarity from the US Fed at the two-day Federal Open Market Committee (FOMC) which concludes on Wednesday.

“We expect Fed to still sound cautious of the growth prospects. We believe that FII flows into equity and debt will continue in India as the rate cut has been delayed for now and rate differentials remain attractive,” said Rao.