The International Monetary Fund (IMF) has cautioned India it should not rely on global financial markets to finance its current account deficit (CAD) when it goes above 3 per cent of gross domestic product (GDP). It advised it to reply more on stable sources of foreign inflow, foreign direct investment (FDI). India's current account deficit has sharply deteriorated over the past few quarters.
The IMF, in its latest external report has noted the real effective exchange rate is in line with the fundamentals with the range of -7 and +5 per cent for 2017-18. It notes that the country's current account deficit rose to around 1.9 per cent of GDP in 2017-18, up from 0.7 per cent in the previous year, partly due to the sharp rise in oil prices. It now expects the deficit to rise to 2.5 per cent of GDP over the medium term “on the back of strengthening domestic demand”. The IMF also now estimates that the sum of FDI, foreign portfolio investments (FPI) and financial derivatives flows on a net basis slowed to 1.9 per cent of GDP in 2017-18 from 2.3 per cent in 2016-17 despite larger portfolio inflows.
Regarding the use of portfolio inflows to finance the deficit, the IMF notes that while “portfolio inflows into government and corporate securities were strong in 2017, leading to almost fully exhausting ceilings on non-resident investment,” they are volatile and are “susceptible to changes in the global risk appetite” as seen during the infamous taper tantrum of 2013. It cautions that given the volatility in portfolio debt flows, “attracting more stable sources of financing is needed to reduce vulnerabilities.” Adding, “implementation of structural reforms to improve business climate would help to attract FDI”.
