RBI Says Cut In Capital Inflows To Have Dampening Effect On Deficit Targets (28-Jul-2010)
Among the several risk factors enumerated by the RBI during its first quarter monetary policy review yesterday, it cautioned on the ramifications of any slowdown in capital flows. In the face of a global slowdown and an increasing risk aversion among global investors, there are fears that the flow of capital into emerging market economies, including India, may reduce. Any such slowdown would impact the current and trade deficit of the economy. The current account deficit has gone up on surging imports due to the faster-than-expected domestic economic recovery.
The current account deficit has already surged by 50% to $21.7 billion during the first two months of the current fiscal from around $14.4 billion a year ago. Increasing domestic industrial activity in the recent months has led to a sharp surge in the country’s total imports compared to the exports level. The increased current account deficit can be bridged by strong capital inflows.
Any potential slump in the foreign capital inflows would have also an adverse effect on the country’s investment scenario which is crucial to achieve a high and sustainable economic growth rate. “Apart from narrowing the comfortable buffer between the current account deficit and net capital inflows, this may constrain domestic investment, which is critical to achieving and sustaining high growth rates,†RBI said.
India’s rapid recovery has resulted in a widening of the current account deficit, as imports have grown faster than exports. In the face of a global economic slowdown, increasing risk aversion amongst global investors may significantly reduce the flow of capital into EMEs, including India.
On the other hand, RBI also mentioned the impact of a possible surge in capital inflows tracking the strong growth potential of emerging market economies, including India. Large capital inflows above the absorptive capacity of the economy will pose a challenge for monetary and exchange rate management. In this scenario, a widening current account deficit will help absorb a larger proportion of the inflows.
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