High CAD Biggest Risk to Inflation: RBI
Flagging record high current account deficit (CAD) as the "biggest risk to inflation and for macroeconomic management", Reserve Bank today raised concerns over the composition of the deficit as well as the nature of capital flows financing the gap.
"It's not the CAD, but the quality of CAD and macroeconomic context in which it is happening, and the type of flows that are financing the CAD, all of these are risk factors," RBI Governor D Subbarao told reporters in the post-policy conference with media here.
He said that high CAD due to import of capital goods is fine, but not acceptable if it is due to higher gold import and other articles which are not productive.
High CAD, which came in at a record 5.4 per cent in the second quarter, is "by far the biggest risk for inflation and for macroeconomic management," he added.
Current account deficit occurs when a country's total imports of goods, services and transfers is greater than the country's total export of goods, services and transfers.
Stressing that around 2.5 per cent of CAD is sustainable, the RBI Governor said 5, 5.5 or 6 per cent, even last fiscal's 4.2 per cent CAD is way above central bank's comfort level.
"A sustainable CAD is 2.5 per cent. Dr Rangarajan has come up with similar numbers. So, anything like 5, 5.5 or 6 per cent is way above that level and we express concern," Subbarao said without divulging the comfort level of the apex bank with respect to CAD. He also refused to commit expected CAD level for the fiscal.
Current account deficit, measured by the difference between country's exports of goods, services and transfers to total import within a time period, touched a record high of 5.4 per cent in the July-September quarter (Q2). The CAD in 2011-12 fiscal was 4.2 per cent.
"Q2 numbers were quite disturbing and CAD will be quite high for the third quarter....That's a problem, because, it has implications for financing the CAD and it has implications for exchange rate stability. Especially, it is happening in the context of slowing growth, our ability to attract capital flows can be affected if growth slows down," Subbarao said adding that high fiscal deficit aggravates the situation.
RBI has raised concerns over the rising Current Account Deficit in the third quarter policy review document, saying it will threaten macroeconomic stability and impact growth.
"Large fiscal deficits will accentuate the CAD risk, further crowd out private investment and stunt growth impulses," RBI said in its policy announcement.
It said that financing the CAD with increasingly risky and volatile flows raises the economy's vulnerability to sudden shift in risk appetite and liquidity preference, potentially threatening macroeconomic and exchange rate stability.
The RBI said that risks in global economy remain elevated with potential for spillovers on Indian economy through trade.
"These forces can potentially increase global risk aversion with implications for financing of the CAD," it said.