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Friday, 20 April 2012 00:00
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With 4% CAD, FII/FDI critical to stop rupee collapse
With a fall of 2.5% against the dollar in just the last fortnight, the rupee is once beginning to look as fragile as it did a few months ago when RBI stepped in and spent $20 bn to defend it—the short period of fall aggravated corporate distress with FCCB redemption pressure rising and with large sections of India Inc's forex exposure unhedged. At that time, however, there were mitigating factors that don't exist today. For one, the current account deficit numbers hadn't come out—when Q3 FY12 data came out last month, it showed a current account deficit of 4.3% of GDP which, apart from being the highest in India's history, wasn't matched by a corresponding hike in forex inflows, so RBI had to draw down on its reserves by $12.8 bn.
On Thursday, while announcing a healthy 21% increase in exports for the year, commerce secretary Rahul Khullar pointed out that with imports rising 32%, FY12’s current account deficit was likely to be 4%. While such a high current account deficit is exerting pressure on the rupee, FII inflows are all but drying up. As compared to $31.5 bn in FY11, FII investments were a lower $19.6 bn in FY12. And while this was achieved by a February surge (FII was $9.2 bn versus $5.4 bn in January and $2.3 bn in December), this collapsed to $1.7 bn in March after the budget came out and to a mere $121.8 mn in April (till yesterday).
FDI inflows, it is true, recovered in FY12 after falling in both FY10 and FY11—the $10-11 bn extra inflows in FY12 were, however, matched by a similar fall in FII inflows. While it is too early to take a call on FDI flows in the months ahead, with investor sentiment being what it is after the retrospective tax amendments (if you include RIL which has a foreign partner, 4 foreign investors are in arbitration against the government) and the new GAAR provisions, it is safe to assume it will take a hit till there is some greater clarity. What is interesting, a study of forex inflows into India between 2001-09 by KS Chalapati Rao and Biswajit Dhar (Boosting FDI flows, and how!, http://goo.gl/ZJUH8) showed about a fifth of FDI in 2009 (this was around 3% in 2005) was accounted for by ‘round-tripping’. In other words, once the tax-treatment changes for investments through tax havens (65% of all funds, including FII, came from tax havens between 2005 and 2009), inflows are likely to be hit badly. India may not be as vulnerable as it was in 1991, as RBI Governor Duvvuri Subbarao said on Saturday, but with the FDI/FII outlook dimming and the rupee under pressure (broking firm CLSA sticks to its R55 to the dollar forecast by end-December), things are looking worrying.

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