RBI raises concerns on India's large current account deficit

Says exchange rate of rupee susceptible to influence of large capital movement because of high CAD

The Reserve Bank of India (RBI) has raised concerns on India's large Current Account Deficit (CAD) as due to this the exchange rate of rupee is susceptible to the influence of large capital movement.

“India has generally been a current account deficit country. In view of the large current account deficit, the exchange rate of the rupee is susceptible to the influence of large capital movements, especially during crisis periods,” said G Padmanabhan, executive director, RBI in Singapore on Friday.

According to Padmanabhan, this does not mean that the country does not aspire to see the rupee as an international currency, particularly as we increase global integration through trade and investment channels.

CAD narrowed sharply to $18.1 billion or 3.6% of Gross Domestic Product (GDP) in the quarter ending March 31 as trade deficit narrowed. In the quarter ending December 31 it had risen to a historically high level of $32.6 billion or 6.7% of GDP. For 2012-13, CAD rose to record high of 4.8% of GDP.

Padmanabhan also stressed on the importance of financial market integration and according to him it is important to the region’s economic development.

“The slow pace and the varying degrees of integration in the region warrant concerted policy actions to surmount the constraints. Asian countries have shown their political support for greater financial co-operation and integration. There is certainly huge scope for channelizing regional savings in the region, particularly say for investments in infrastructure development. There is a need to address obstacles in areas such as differences in economic structure and development, maturity of individual markets and infrastructure,” he said.

In the past there have been proposals regarding formation of an Asian Monetary Union. However, according to Padmanabhan, ASEAN countries are nowhere near forming a single market as in the European Union (EU) as these proposals have reached not reached anywhere.

“Full-fledged integration in the region will require creation of a supranational institution on the lines of EU but that is just a far-fetched thing at this juncture. The lessons from not so happy experience of European integration through a monetary union mechanism will also weigh on the minds of the Asian policymakers,” said Padmanabhan.

According to Padmanabhan, the greater integration and internationalization of Asian currencies would require an agreement between the participating countries to be bound by collective decisions rather than bilateral ones.

Padmanabhan is of the view that currency internationalization, which entails market liberalization, requires putting in place regional financial market infrastructure that includes a regional system of clearing and settlement, regional credit guarantee institutions, hedging facilities, and regional credit rating agencies to foster cross-border investments. This will also need to be accompanied by the harmonisation of legal and regulatory systems, market practices, rating standards, accounting and auditing practices, and withholding of taxes on bond coupon payments across countries in the region.

He added that additionally, greater internationalisation of Asian currencies would require existence of well developed  and deep forex markets with diversified forex hedging instruments, which will facilitate issuance of foreign bonds in domestic markets and local currency bonds by foreign entities. At the present juncture, such preconditions are not being fully met in the region.

According to Padmanabhan a number of recent studies on integration of Asian financial markets have, based on empirical analysis, concluded that regional integration of Asian financial markets, both equity and debt markets, have progressed over the years but is still incomplete and there is a lot of divergence in the level of integration.