If the US economy recovers, can India catch a flu? Many analysts reckon it could.
India's yawning current account deficit (CAD) - shorthand for overall foreign exchange gap - could get worse as things get better in the US. Here's why.
The central bank of US, the Federal Reserve, has signalled the phase-out of an easy pumping in of cash to fan demand and growth -- called the third round of quantitative easing (or QE3). And this will take out money countries such as India.
A reversal of capital inflows would likely make Indians pay more rupees for each dollar, which means it needs hard forex to bridge the CAD-a broad measure of what India earns from the rest of the world and what it pays. The CAD has touched a historic low at 4.8% of GDP in 2012-13. However, it fell to 3.6% in January-March, from 6.7% in the previous quarter in.
But all told, a wide CAD could delay a growth recovery in India, fan inflation (because it costs more to buy precious oil) and keep interest rates high. Low interest rates are vital to expanding the economy in order to spin jobs and multiply incomes. (see graphic).
“We should also remember that the Reserve Bank of India (RBI) as the country’s central bank can only print rupees to increase domestic money supply. It cannot print foreign currency. If we have to borrow $80-100 billion year after year, and don’t do anything about it, the exchange rate will overshoot and reach stratospheric levels,” said a senior policy analyst, who did not wish to be identified.
Gold imports, in wake of the curbs that the government has imposed, can bring down the CAD, but “financing the CAD this year will be the key challenge, as not only are there risks from lower portfolio inflows, but debt inflows such as short-term trade credit also suggest caution,” said Sonal Varma, economist at broking and research firm Nomura.
The money could come from foreign investors -- either portfolio funds or companies setting up facilities.
Capital market regulator Securities Exchange Board of India (SEBI) on Tuesday announced a slew of measures including simplifying rules and registration procedures for foreign investors. Analysts said given its relative stability, foreign direct investment are more welcome.
“Higher reliance on short term foreign capital has increased the external account vulnerability,” said Dharmakirti Joshi,chief economist, CRISIL Research.