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Posted by: Deepa Vasudevan on Thu, Dec 12th, 2013

A More Stable External Account

In August 2013, when the rupee fell to a low of 68 against the US dollar and FIIs were pulling out funds from the capital market, the current account deficit was expected to be around $85 billion. India’s ability to fund the deficit through foreign inflows was in question. Our blog dated August 7, 2013, estimated that there could be a shortfall of $25 billion between inflows on the capital account and the current account deficit for 2013-14[1]. The country appeared to be heading towards a Balance of Payments (BoP) crisis.

 

As we approach the last quarter of the year, there is a significant shift in the BoP situation. The impending shortfall in foreign inflows has been plugged through two strategies: import compression and dollar accumulation through new routes. The first was implemented through sharp increases in import duty and restrictions on imports of gold and some non-essential imports. The impact was swift; the CAD dropped from US$21 billion in the first quarter to US$5 billion in the second quarter. As a result total CAD for the first half of 2013-14 at $26 billion was much lower than the $38 billion recorded in the first half of 2012-13.

 

But the real game changer was the opening of a special swap window that allowed banks to hedge fresh 3 year FCNR (B) deposits in selected currencies with the RBI at a fixed rate of 3.5%. The low swap cost was a strong motivator; by November 30, when the swap window closed, banks had collected $34 billion in such deposits.

 

Table 1 shows how the pattern of foreign capital flows has changed this year. NRI deposits are the largest contributor to inflows so far, and could easily reach $20 billion by year end[2]. Assuming that FDI inflows and loans through ECBs/FCCBs garner $20 billion each, we would have inflows of $60 billion on the capital account, not counting portfolio flows. Net portfolio flows were negative in Apr-Oct, but market sentiment has picked up subsequently. The first ten days of December alone saw net inflows of $1.7 billion, largely in response to the election results. So it should be safe to assume that fresh portfolio inflows in November 13- March 14 will erase the impact of sell-offs in the first half of the year. A net positive amount would be a bonus!

 

Table 1 Flow of Foreign Capital

InsightsMore stable BoP-10 Dec 2013_T

Source: RBI

 

Estimates of CAD range from $60 billion to $70 billion. It should be possible to compress CAD to $60 billion provided (i) gold imports do not shoot up, especially during the winter wedding season and (ii) exports do not lose momentum with the stabilization of the exchange rate. With some vigilance, therefore, the problem of funding CAD appears to be over for this year.

 

As always, the risk is with portfolio inflows, which can reverse by amounts large enough to overturn all calculations. The $10 billion that was pulled out by FIIs in June-July 2013 shook forex markets and investor confidence. It has taken the RBI an entire quarter to restore some stability, hopefully, this situation will continue.



[2] Freedom to set interest rates on Non resident (external) Rupee accounts without a ceiling has been extended to January 2014 to attract more NRI funds

 

Ajit Purohit on Wed, Dec 18th, 2013 5:05:33 pm

Excellent analysis.

Chandrahas on Fri, Dec 13th, 2013 1:48:18 pm

Bond yield seems to be increasing & remaining at top consistently. Its affecting debt schemes largely.

Giridhar Gobindaram Gianchandani on Fri, Dec 13th, 2013 12:41:14 pm

Q: To what extent can the Rs appreciate vis-a-vis US $ till April 2014? What about the forth coming election effect?

Sandeep Bhushetty on Fri, Dec 13th, 2013 11:27:00 am

when Doller touch 68 mark that time through Pnotes FII's pulled Doller from Indian Market..I fell even now in country like Singapur shorting of Indian Rupee by traders aggresively creat same cercomstances again..

sandeep on Thu, Dec 12th, 2013 6:42:09 pm

Excellent analysis

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