Financing of CAD poses challenge, says RBI report

The Reserve Bank of India (RBI) in its Financial Stability Report (FSR) issued on Thursday voiced concern over India’s current account deficit (CAD) — though it registered a sharp fall in the fourth quarter — saying that financing the same through stable flows will remain a key challenge.

High dependence on portfolio and short-term flows is an added concern, said RBI in its Financial Stability Report (FSR) adding:

“Non-disruptive financing of the high CAD and containing its size within sustainable levels has become the key challenge ion managing the external sector and especially mitigating its vulnerability to global shocks.”

CAD for the January-March period was $18.1 billion, or 3.6 per cent of GDP – which is lower than the market estimate, but it fell below the $21.7 billion deficit a year earlier. The high CAD is also exerting pressure on the rupee which has weakened over 12 per cent against the dollar since the beginning of May.

The latest issue of FSR — seventh in the series — is being released at a time when debate about the appropriateness, timing and pace of imminent exit from unconventional monetary policies by the US is intensifying and the consequent tremors are being felt in financial markets across the globe.

Further, the apex bank voiced concern on the rise in the country’s external debt which stands at $390 billion as of end-March 2013, an increase of $44.6 billion or 12.9 per cent over the level at end-March 2012.

According to the report, the increase in total external debt during financial year 2012-13 was primarily on account of rise in short-term trade credit. RBI has observed that there has been sizeable rise in external commercial borrowings (ECBs) and rupee denominated non-resident Indian deposits as well. The other factor which is contributing to the widening of CAD was rising share of gold imports. As per RBI data, the share of gold import to total import has been rising steadily since 2007-08 and was close to 3 per cent of GDP in 2012-13.

The government and the central bank have been taking several steps to curb gold imports like hiking import duty, advising lenders not to lend for the purchase of gold, among others. These steps are expected to reduce gold import in the country. Though lower commodity prices and moderation in gold imports could help narrowing the deficit but high CAD in a sluggish economy poses difficult macroeconomic policy challenges, the central bank observed.