What is even dangerous is that this CAD is being financed mostly by portfolio inflows and not be FDI. Rise in CAD is inevitable since domestic savings have been falling faster than the fall of investment. With the government failing to ensure fiscal prudence (save for the lip service) and unable to put the inflation genie back in the bag, domestic savings have taken a big hit.
I have explained on a number of occasions earlier, India’s real fiscal deficit for FY13 will be north of 5.5% of GDP. As a result, India’s twin deficit for the year will tot up to 10.5% of GDP. In fact, closer to 11% -higher than what it was last year.
Being helpless in tackling the problems facing the economy and unable to attract adequate FDI (by failing to meaningfully walk the talk), the government is taking every possible steps to attract portfolio flows to help finance the CAD. This, however, is the least desirable solution. Given the current state of the economy, even the relative attractiveness of the Indian economy remains questionable, atleast till the elections. Till then, if the situation does not improve for India and, even worse, if the European situation worsens (which is quite likely given the potential ramification of the Cyprus decision) the FIIs can exit India in large numbers. In such a situation, forex reserves will dwindle, the rupee will depreciate and inflation would remain elevated. A pretty scary situation, to say the least.
Unfortunately for India, the biggest policy driver is hope. The policy makers prefer to do nothing but hope that things will improve. Since September last, we have seen a plethora of announcements but hardly anything coming to fruition. The very fact the India is as yet unable to attract even a single investment commitment after FDI is multi-brand retail was liberalized, speaks volumes of how our policy and policy makers continue to fail India.
Bottomline – be prepared for the worst, at least till the elections are over. And, hope for the best, post that.