Balance of payments shortfall: Street trashes govt's estimates

While the govt expects a shortfall of $6 bn, market believes an FII sell-off could push it to $25 bn

The rupee's recent fall has bewildered the government because nothing it does is able to stem it. Anyone who listened to economic affairs secretary Arvind Mayaram during an investors' call on Tuesday would believe the government has a plan in place to save the rupee. The Street, however, believes the government's arithmetic isn't factoring in portfolio outflows, which could be as high as $20 billion. It is clear the government and the market are not on the same page.

The first difference between Mayaram's and the market's assumption is that inflows will stabilise. Even though the total capital outflows from debt add up to $9 billion, the government believes things will settle after foreign institutional investors (FIIs) sell un-hedged exposure.

Second, the market believes the government is under-estimating the dollar shortfall and it isn't raising enough dollars to fund the gap. The government has factored in a balance of payments (BoP) shortfall of $6 billion for FY14 and it plans to raise $11 billion through quasi-sovereign bonds, liberal interest rates for non-resident deposits and opening up the external commercial borrowing segment for public sector enterprises. The market expects a shortfall of $20-25 billion. In the investors call on Tuesday, Mayaram explained: "You cannot be looking for buffer of $20 billion only, that's an irrational demand." Over the next couple of months, public sector enterprises alone would have raised $4 billion through external commercial borrowing (ECB) and once this happens, the rupee might stop its one-way move. Also, the government is confident of curtailing the current account deficit (CAD) at 3.7 per cent of GDP in FY14 from last year's 4.8 per cent.

This may not be enough, according to Chetan Ahya, chief economist at Morgan Stanley. He says India will remain exposed to the trend of the US dollar and real interest rates as long as India's CAD remains higher than a more sustainable level of 2.5 per cent of GDP (implying trade deficit at 8.5 per cent of GDP) and consumer price index (CPI) inflation remains higher than seven per cent. Rakesh Arora, head of research at Macquarie Capital, is worried the government is not factoring in FII sell-off. "What happens if outflows pick up? If $20 billion leaves the country, then we will be looking at a BoP shortfall $26 billion. Also, what if companies cannot refinance their ECB debt that matures this year?" he questions.

In contrast, Mayaram's faith in FIIs is resolute. He cites the trend of the last 15 days, when FII flows have remained positive in equities. He says: "If you look at equity side, from July 30 onwards, it has been net positive day-to-day. FIIs have greater faith in India than domestic investors. The sellout is broker-led and not investor-led." Yet, for those who believe outflows will accelerate, Mayaram says the government does have a plan to make portfolio investments attractive for foreign investors.