Capital Markets: Challenges and Developments

The rising risks to financing India’s current account deficitPriority 1


Note4students

Mains Paper 3: Economy | Indian Economy

From UPSC perspective, the following things are important:

Prelims level: CAD, BoP

Mains level: Impact of rising crude oil prices on CAD and other vulnerabilities.


News

Higher oil prices are raising India’s CAD

  1. The higher current account deficit will put downward pressure on the rupee and it may also raise the cost of Indian borrowing abroad.
  2. The stress on BoP is already visible in Q1FY19 with the INR depreciating 4%; the RBI had to intervene to stem the depreciation.
  3. NRI flows too have proved to be volatile, especially if the rupee depreciates.

Financing CAD is risky

  1. It’s not just that the current account deficit is widening—the means of financing it also became riskier in 2017-18.
  2. On the one hand, higher oil prices are raising the current account deficit and on the other, foreign direct investment—the most stable source of financing the deficit—has come down.
  3. This has led to greater reliance on foreign portfolio inflows, particularly volatile debt inflows and also on short-term credit.

Why such Problem?

  1. This is a problem because the US Federal Reserve has been raising interest rates and has signalled more rate hikes to come.
  2. As per RBI governor the US programme of shrinking its balance sheet, coupled with increased US T-Bill issuance to fund a larger government deficit, has already led to dollar liquidity shrinking in international markets, particularly in the debt markets.
  3. This is behind the outflows from emerging market debt.

Cost of Protectionism

  1. The rapid deterioration in the trade environment as a result of protectionist policies is also likely to affect export growth, while rising investment demand will result in more imports.
  2. The UNCTAD, had in its recent World Investment report pointed to a slowdown in global foreign direct investment flows.

Dependence on FPI is dangerous

  1. Relying on portfolio flows to finance this deficit will expose the country to the vulnerabilities of uncertain international capital flows, making funding difficult particularly during risk-off episodes.
  2. Within portfolio flows, the increased reliance on debt inflows carries more risks, as unlike equity, debt has to be repaid.
  3. Earlier this month, credit rating agency Moody’s Indian affiliate, ICRA Ltd, said high global crude oil prices are likely to widen India’s CAD and pointed to slowing foreign portfolio investments as an area of concern.

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