India needs to focus on FDI, cautions against dependence on global markets: IMF

25 Jul 2018 Evaluate

Amid expectations that India’s current account deficit (CAD) will rise to 2.5% of gross domestic product (GDP) in the first quarter of current fiscal year (FY19), the International Monetary Fund (IMF) in its latest external sector report has expressed caution on India and said that it should not depend on global financial markets to finance its CAD when it goes above 3% of GDP. IMF has suggested the country should focus more on stable sources of foreign inflow that is foreign direct investment (FDI). It also said that the country needs to allow its rupee to be driven by market forces to minimize external risks and should intervene only to address disorderly market concerns. It noted that the real effective exchange rate (REER) is in line with the fundamentals with the range of -7 to +5 per cent for 2017-18.

The report said that India’s CAD has sharply deteriorated over the past few quarters. Besides, the CAD is estimated to rise to about 1.9% of GDP in FY18 from 0.7% of GDP in the previous year. Reflecting a recovery in commodity (especially oil) prices, imports surged by 19% in FY18, following a slight decline in the previous year. Export growth also picked up to 10% in FY18, from 5% in FY17, in line with the global growth recovery. Over the medium term, the CAD is expected to increase to about 2½ percent of GDP, on the back of strengthening domestic demand.

The IMF estimates that the sum of FDI, foreign portfolio investments (FPI) and financial derivatives flows on a net basis slowed to 1.9% of GDP in 2017-18 from 2.3% in 2016-17 despite larger portfolio inflows. On the use of portfolio inflows to finance the deficit, it noted 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. It added that implementation of structural reforms to improve business climate would help to attract FDI.

On the external debt front, the IMF notes that at about 20% of GDP, India's external obligations are moderate, compared with other emerging market economies. 48% of the external debt is denominated in US dollars and another 37% is dominated in Indian rupees. The debt maturity profile is favorable, as long-term external debt accounts for about 81% of the total, and the ratio of short-term external debt to foreign exchange (FX) reserves is low.

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