|The problem with CADs|
|Monday, 19 December 2011 00:00|
Can’t delink Rupee’s fall from the much higher deficit
Though RBI intervention last week, in terms of both selling dollars as well as changing the policy on long positions, helped the rupee recover a large part of its fall in recent weeks, it’s important to keep some perspective on what made the rupee fall and what RBI can realistically do to reverse matters. For one, given the relative levels of inflation in India and overseas, it can be no one’s case that 46 was the right value to the dollar, a value around 50-51 seems a lot more appropriate.
Add to that the deterioration in the current account deficit (CAD) and the lower availability of capital flows to make good the deficit. India’s CAD has been rather low (just over 1% between 2005 and 2008 and 2.3-2.8% in 2009-11), thanks to the sharp growth in software and BPO income from abroad and remittances that tended to somewhat offset the widening deficit in goods trade that peaked at 9.7% in 2008-09 and stood at 7.5% in 2010-11—exports in the latest month grew just 3.7%, the lowest in the last two years or more. In contrast, the current account deficit this year is going to be 3% or higher—as compared to this, the Prime Minister’s Economic Advisory Council had targeted a lower 2.7% of GDP. Capital flows are also lower than what was targeted—between August and now, FIIs withdrew $2.3bn as compared to the $18bn they put in during the same period last year. With around $140bn of India’s $300bn of reserves due to mature in the next one year, with no
certainty if lenders would like to renew it given the global crisis, RBI’s fire-power is considerably lessened. Though, as Thursday’s intervention showed, RBI still has several arrows in its quiver. In the final analysis, however, it depends on how the government is able to convince investors it plans to go ahead with making India more investor-friendly.