India could see some slowdown in capital inflows going forward as advanced economies exit from the easy monetary policy, making it tougher to fund a widening current account deficit, the Reserve Bank of India (RBI) said in its Financial Stability report.
“Financing of current account deficit is going to be a challenge as advanced countries begin exiting from their accommodative monetary policy stance,” the RBI said in the report, released on Tuesday.
If oil and commodity prices remain elevated, the current account deficit will remain significant, although higher growth in software exports and remittances may provide some cushion, the report said.
India’s exports in May provisionally rose an annual 56.9% to USD 25.9 billion, while imports for the month rose 54.1% to USD 40.9 billion.
The country’s trade deficit widened the most in nearly three years as the country’s demand for oil, gold and industrial machinery soared, prompting concerns the gap for the fiscal year could expand despite a strong rebound in exports.
India’s trade deficit rose 67% in May from a month ago to USD 15 billion, the highest since September 2008.
The Reserve Bank said it is committed to use a prudential mix of policy instruments to contain any adverse impact of easy monetary policy by the advanced economies.
The GDP growth has downside risks on account of some domestic and international factors, the report noted.
“The slackening of global recovery, high oil and commodity prices, deceleration in domestic industrial growth, uncertainty about continuation of strong growth in agricultural sector and impact of monetary policy actions pose downside risks to India’s GDP growth during 2011-12,” the RBI said.
India’s economy expanded 8.5% in the fiscal year ended March, and the central bank has forecast growth to moderate to about 8% in the current fiscal year.
Inflation is likely to face upward pressure from higher subsidy expenditure of the government, rise in wages and raw material prices, RBI said in the report.
“Management of government expenditure, especially subsidies bill, will pose challenges to the process of fiscal consolidation, which could be further accentuated by a tempered growth adversely impacting revenue collection,” the central bank said.
High interest rates has increased the attractiveness of overseas borrowing in terms of interest rate differential and availability of credit, it said.
The high and growing net external liability position of residents exposes the country to the risk of a sharp fall in the currency, the report noted. The central bank also said increased reliance on market borrowing by Indian banks could adversely affect their liquidity position.