Slowdown in capital inflows could upset deficit targets: RBI.

MUMBAI: The Reserve Bank of India has said that the economy could face a significant risk in the form of a slowdown in capital flows, at a time when the current account deficit is widening.

In its first quarterly review of monetary policy, the Reserve Bank of India said that a potential slowdown in capital inflows could impact the current and trade deficit. The current deficit is already widening as imports continue to rise with the rebound in economic growth.

The current account deficit, which is a measure of higher imports of goods and services over exports, has already risen 50% to $21.7 billion during April-May 2010 from around $14.4 billion a year ago.

The gap can be covered by inflows. “Apart from narrowing the comfortable buffer between the current account deficit and net capital inflows, this may constrain domestic investment, which is critical to achieving and sustaining high growth rates,” RBI said.

In the face of a global slowdown and an increasing risk aversion among global investors, there are fears that the flow of capital into emerging market economies, including India, may reduce.

The data available so far for the current year (FY11) indicate a moderation in capital inflows. While foreign direct investments (FDI) have been more or less flat at close to $4.4 billion, there has been a slowdown in net foreign portfolio investments ($6.2 billion during April-July against $8.7 billion in the year-ago period) and net NRI deposits ($1.3 billion vs $1.8 billion)

RBI has said that the risk of capital flows runs both ways. Given the present state of the global economy, central banks in advanced economies are likely to maintain accommodative monetary policies for an extended period.

With the strong growth potential of emerging market economies, including India, this is likely to trigger large capital inflows. Large capital inflows above the absorptive capacity of the economy will pose a challenge for monetary and exchange rate management. This also has implications for asset prices. In this scenario, a widening current account deficit will help absorb a larger proportion of the inflows.

Source : economictimes.indiatimes.com