BackNot in a comfort zone
The govt should take steps to attract direct equity investments and reduce the dependence on debt, while attempting to control CAD
Premium(Jayachandran/Mint)
India’s current account balance in the first quarter of the current fiscal (April-June 2012) has improved. The deficit, in the absolute terms, narrowed to $16.6 billion compared with $17.5 billion in the same quarter last year and $21.7 billion in the last quarter of the last fiscal. The improvement is clearly visible on the exchange rate ticker. There is, however, no reason to begin cheering. There are two potential sources of trouble that can turn into challenges anytime. First, the quantum of the deficit is still sufficiently large to disturb the balance of payments. Second, the dependence on the debt flows, especially of short-term variety, continues to affect, in a negative manner, the size and the composition of external debt.
Even at the moderated level, the current account deficit (CAD) is so large that India will need foreign inflows in the capital account in excess of $5 billion per month to bridge the gap. In the present global environment, that does not allow the country to reduce its dependence on debt flows. This could be self fulfilling—allowing more debt flows to repay the maturing ones—with future consequences.
The total external debt has already surpassed the foreign exchange reserves by a wide margin, as reserves are now just about 83% of the total liabilities compared with 138% in 2007-08. And this figure is deteriorating. Further, the short-term debt to reserves ratio now stands at 27.8% compared with 14.8% in 2007-08 and is rising consistently. The composition of the external debt, too, is a reason for worry: the proportion of short-term debt has gone up by full 3 percentage points between March 2010 and June 2012. These are certainly not the numbers that can offer comfort to policymakers, both at the Reserve Bank of India and in the government of India.
As the short-term component of debt is on the rise along with the total liabilities, there are reasons to exercise care on the quantum and the quality of debt flow that reaches Indian shores. Propping up the currency and funding the current account with short-term debt inflows is a self-defeating option. The government will do well to take steps in order to attract direct equity investments and reduce the dependence on debt, while making an attempt at the same time to control CAD, which, to large a extent is a consequence of excess government spending and artificial suppression of prices in a variety of products.
Are India’s external finances a cause for worry?
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