The CAD is not driving rupee down, capital flows are
Much of the government’s emphasis over the past few weeks has been on controlling the current account deficit (CAD), whether by way of compressing gold imports through duty hikes or by trying to lower oil imports while providing incentives to boost exports. While the finance minister’s statement that he would keep the CAD to under $70 billion in FY14 was met with initial scepticism, the rapidly slowing economy—and the impact of the falling rupee in compressing non-gold non-oil imports—suggests this may well be a reality. But what is driving the rupee down is not just the CAD—indeed the CAD has been improving since June—but increased outflows on account of fears of the US taper and the economy doing badly. Between January and May, when due to less fears of the taper starting anytime soon, $19.3 billion of FII funds flowed in, but the rupee still slipped from 53.3 per dollar to 56.5. Between June and now, when $12.4 billion flowed out, the rupee naturally fell even more, to 66.01 currently.
While the outflow has been mostly in debt funds—$3.5 billion of outflows were in equity and $8.9 billion in debt—the fear now is that with the rupee playing havoc with corporate earnings, and the slew of GDP downgrades, you could see a possible increase in equity outflows. Add to this that part of the $172 billion short-term debt due by March 2014 which doesn’t get rolled over, and it is apparent India’s real problem is not the CAD but the balance of payments (BoP)—how much will get rolled over will depend on the new spreads and the viability of already stressed borrowers who, in some cases, have EBITs that is lower than the interest payments. Compressing the CAD is of little use, BoP flows will get staunched only by a big dose of reforms, more so given the slew of populist Bills like those on land acquisition and food subsidies.