Better sentiments may cut external risk

The improvement in global investor sentiments may ease the headache of managing risks on the external front for the Reserve Bank of India (RBI). The apparent stabilisation in advanced economies – visible over the past few weeks – appears to have improved global investor sentiment, resulting in a steady increase in capital inflows into emerging market economies (EMEs), including India.

“If this trend continues, the risks on the external front will clearly abate, despite exports remaining sluggish,” RBI said in its first mid-quarter review of the monetary policy for 2010-11.

The continuing sluggishness of the global economy constrains export growth, while the strong domestic recovery has increased demand for imports.

This had led to the widening of trade deficit as well as the current account deficit, RBI further said.

In its July policy review, RBI had highlighted the risks associated with a widening current account deficit in the face of increasingly volatile capital inflows.

At that time, RBI had also expressed concerns over the global outlook. The indicators of economic activity in advanced economies then suggested that the recovery was slowing.

The second half of 2010 could post slower growth than the first, although expectations have generally not been revised downwards since end-July. Belying earlier apprehensions, Europe has demonstrated remarkable resilience in the face of the sovereign debt pressures that severely threatened the recovery a few months ago.

The European Central Bank has revised upwards its growth forecast for the second-half. China, after showing some signs of slowdown in the second quarter of 2010, appears to have bounced back, with industrial production and trade numbers reviving sharply.

Overall, even as the global environment continues to be a cause for caution, the big picture has not worsened significantly since July.