Centre’s measures to boost capital inflows will slow, not reverse Re slide: Moody’s

Global agency Moody’s believes that the Centre’s five-point programme to increase dollar inflow will not reverse the slide in the rupee. At best, these can slow rupee depreciation. The agency also fears that fiscal deficit might be wider than the target.

According to the agency, the Government estimates that the measures will increase capital inflows by $8-$10 billion, or 0.3-0.4 per cent of GDP, in the fiscal year that ends March 31, 2019.

India’s basic balance (current account plus net foreign direct investment) averaged a deficit of about 0.7 per cent of GDP in the first two quarters of calendar 2018. Thus, “even if the capital account measures have an immediate impact on flows, they will only partially cover India’s remaining financing requirement and alleviate only some of the depreciation pressure on the rupee,” the agency said in a note.

The five measures

After a detailed review meeting chaired by the Prime Minister Narendra Modi on September 14, Finance Minister Arun Jaitley announced five measures to rein in the rupee. These include, import curbs on non-essential items (specific items to be announced later), review removal of exposure limit of 20 per cent of foreign portfolio investors’ (FPI) corporate bond portfolio to a single corporate group and 50 per cent of any issue of corporate bond, no withholding tax on Masala Bonds issued during the current fiscal, manufacturing firms will be able to avail loans of up to $50 million with a maturity of one year and review of mandatory hedging condition for infrastructure loans. The income-tax department has already announced withholding tax exemption while list of specific items for import curb expected to be out ‘very soon’.

Import bill

The rupee has depreciated more than 10 per cent against the US dollar since January 2018. Even on Monday it opened lower at 72.47 to the dollar against Friday's close of 72.20 a dollar. Adjusted for consumer price inflation, the real effective exchange rate depreciated by about 7 per cent between December 2017 and August 2018, giving a boost to India’s trade competitiveness. “Concurrently, measures to curb non-essential imports, which individual ministries are to announce soon, might help to contain the import bill, but will likely have a lagged effect,” the agency said.

India’s current-account deficit widened to 2.4 per cent of GDP in the first quarter of fiscal 2019 from 1.9 per cent the previous quarter, driven by higher oil and non-oil imports. With limited tools to influence the current account in the short term, the government is looking at the capital account to shore up demand for the rupee.

Macroeconomic fundamentals

Nevertheless, the agency said, strong macroeconomic fundamentals will keep the credit risks of a weaker currency at bay. At current levels, India's current-account deficit is still much narrower than the near 5 per cent of GDP posted during the “taper tantrum” period in 2013, when the currency depreciated by nearly 20 per cent between May and August.

Moreover, India’s External Vulnerability Indicator, the ratio of external debt payments due over the next year to foreign exchange reserves, remains low at 65 per cent when compared with its peers. Although foreign reserves have declined by 5.7 per cent to $376.6 billion since peaking in March 2018, they are significantly higher than their level of around $250 billion in 2013. “The large foreign-currency reserves provide additional policy space and flexibility for the central bank to manage external shocks and reduce the risk of sustained and large portfolio outflows, as well as pressure on the currency,” it said.

Pressure on fiscal deficit

The agency noted the Government’s reiteration of limiting the fiscal deficit to the budget target of 3.3 pe cent of GDP. However, the agency felt that subsidy bill likely to go up because of surge in oil prices and will add to existing pressures on India's fiscal position. Those pressures include the lowering of goods and services tax rates on a range of consumer goods and a tax cut for small businesses, as well as the relatively high minimum support prices set for this year.

“We, therefore, see risks that the central government deficit will be wider than targeted and expect the general government deficit (central and states) to be around 6.3 per cent of GDP in fiscal 2019, compared with 6.5 per cent the previous year,” it said.

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