Can this lower current account deficit?

Tue, 12 Mar Pre-Open

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Widening current account deficit (CAD) has been a matter of grave concern for the Government. It is believed that the deficit could be in the region of 5% for the year ending 31st March 2013. Increasing imports due to rising crude and gold prices is the primary reason for increasing CAD which is well above the comfort level of the government. So, in order to curb the same the government is likely to announce ambitious set of reforms.

It plans to increase or scrap the Foreign Direct Investment (FDI) limit in certain sectors. Scrapping/increasing the limit will attract foreign investments and thus help build exchange reserves. Sectors such as banking and telecom where the permitted FDI limit is 74% are on the hit list at the moment. Plus, insurance and pension bills are already awaiting FDI approval in the parliament. We feel that this is a step in the right direction. Earlier the sectoral caps were levied to offer protection to the domestic industries. But now the Indian corporates are much capable to withstand the foreign competition. Thus, there is no need to offer external protection. Off course, where there is a need the caps would be continued. Thus, the idea of tinkering with the limits makes sense as it does not jeopardize domestic companies.

It may be noted that India's CAD has been increasing persistently. And if innovative steps are not taken to finance the same the Indian currency could weaken. Until now India was reliant heavily on foreign debt flows to finance the deficit. But considering that they have to be repaid in future it does not offer a long term solution. As such, India needed a much stable and long term financing measure to take care of the rising CAD. And increasing FDI limits is a solution to that.

But will it really solve the problem?

Indication to increase the limits does show the intent of the government to welcome foreign capital. However, the business environment at home is not conducive. Red tapism and wide spread corruption is making the matters even worse. So, even if the limits are raised whether the foreign capital will really come in is a matter of debate. If the government really wants to attract long term foreign capital the ease of doing business in India must improve. Or else reforms not matter how innovative they are; will not produce the desired results.