IMF wants India to focus on FDI, cautions against relying on global markets

Cautions against relying on global financial markets to its finance current account deficit

The International Monetary Fund (IMF) has cautioned India it should not rely on global financial markets to finance its current account deficit (CAD) when it goes above 3 per cent of gross domestic product (GDP). The Fund basically advised India to rely more on stable sources of foreign inflow — foreign direct investment (FDI).

The advice came amid expectations that India's CAD will rise to 2.5 per cent of GDP in the first quarter of 2018-19.

On the contentious issue of the rupee’s value, the Fund in its latest external report has noted the real effective exchange rate (REER) is in line with the fundamentals with the range of -7 to +5 per cent for 2017-18.

India's current account deficit has sharply deteriorated over the past few quarters. As the report, released on Tuesday, notes, the country’s current account deficit rose to around 1.9 per cent of GDP in 2017-18, up from 0.7 per cent in the previous year, partly due to the sharp rise in oil prices.

The Fund now expects the deficit to rise to 2.5 per cent of GDP over the medium term “on the back of strengthening domestic demand”. As a consequence, its net international investment position to GDP ratio is expected to deteriorate. 

Financing the current account deficit is likely to be tricky.  While FDI flows have increased, they are not sufficient to cover the deficit. 

The Fund estimates that the sum of FDI, foreign portfolio investments (FPI) and financial derivatives flows on a net basis slowed to 1.9 per cent of GDP in 2017-18 from 2.3 per cent in 2016-17 despite larger portfolio inflows.

On the use of portfolio inflows to finance the deficit, the IMF notes that while “portfolio inflows into government and corporate securities were strong in 2017, leading to almost fully exhausting ceilings on non-resident investment”, they are volatile and are “susceptible to changes in the global risk appetite” as seen during the infamous taper tantrum of 2013.

It cautions that given the volatility in portfolio debt flows, “attracting more stable sources of financing is needed to reduce vulnerabilities”.

It adds that “implementation of structural reforms to improve business climate would help to attract FDI”.

The Fund has noted India’s foreign exchange reserves are adequate for precautionary purposes. The country's forex reserves reached $424.5 billion at the end of March this year, declining thereafter to about $412 billion as of May. At current levels, the reserves represent about 190 per cent of short-term debt and about 7.5 months of prospective goods and services imports.

On the contentious issue of the rupee’s true value, the Fund notes that as of May 2018, the REER depreciated 3.6 per cent relative to its 2017 average. 

On the external debt front, the IMF notes that at about 20 per cent of GDP, India's external obligations are moderate, “compared with other emerging market economies. 48 percent of the external debt is denominated in US dollars and another 37 percent is dominated in Indian rupees. The debt maturity profile is favorable, as long-term external debt accounts for about 81 percent of the total, and the ratio of short-term external debt to foreign exchange (FX) reserves is low”.