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FIIs Wary of widening current account deficit

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FIIs Wary of widening current account deficit
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j_ritu is on a distinguished road
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FIIs Wary of widening current account deficit - June 3rd, 2006

FIIS are showing India a red card over its widening current account deficit. A current account deficit is not new to India’s balance of payments (BoP) situation, but large FII inflows is.

The current instability on the BoP front is not because of bulging trade and current account deficits, but is owing to its dependence on FII flows for financing the deficit.

When the flows were net positive, the going was good, but a net FII outflow of $1.6bn in May ‘06 was enough to bring out the risk in the open. What’s more, a large dollar outflow and a steady increase in imports have put immense pressure on the rupee, which has depreciated by nearly 3.4% in the past month.

The RBI is therefore in a quandary; if it allows the rupee to depreciate further, it might slow down import growth. It may also trigger larger FII outflows, leading to a bigger slide in markets and hurt investor sentiment. On the other hand, if the rupee appreciates, it may give some relief to FIIs, but imports would become cheaper and the trade deficit could widen further.

With FIIs forming nearly 55% of the country’s capital inflows during April-December ‘05, the pressure on the Central Bank to stall the current fall in the rupee would be high.

Imports, both oil and non-oil, however, are already increasing by 27%, higher than the export growth of around 19% during April-January ‘06. Expecting exports to grow higher than this rate is wishful thinking, which leaves the search for stable inflows such as foreign direct investment.

FDI in capital inflows fell from 55% in ‘02 to barely 10% in ‘05, rising to 32% during April-December ‘05. The political will to take it higher is missing.

As far as capital flows are concerned, FIIs know the answer to when the tide will turn, after all, it is they who are pulling money out, which makes their concern seem even more out of place.

Source: ET, Sat 03-06-06

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