What policy makers will now have to focus on are concrete measures to bring down the import bill and a long term strategy to boost exports, which will help address the current account deficit problem.
An unintended blessing of the likely end to cheap foreign capital flows is that Indian policy makers may finally be forced to come up with longer term solutions to address the problem of current account deficit, as well as the means to finance it.
In April this year, the Prime Minister's Economic Advisory Council (PMEAC) had estimated current account deficit for this fiscal at USD 100 billion, and FII inflows at USD 18 billion. For now, the second estimate now appears to be at risk, with the US Federal Reserve more or less having made up its mind to scale down the monetary stimulus it has been injecting into the economy.
Till at least a month back, increasing investment limits for FIIs in government securities and corporate bonds, and encouraging companies to borrow capital abroad, were among the key policies to boost dollar flows into the country. It is by now evident that such quick-fix solutions are not working.
The unprecedented depreciation in the rupee is hurting companies with huge foreign loans on their books. And a combination of weak rupee plus rising US government bond yields has prompted FIIs to dump government securities worth Rs 27,000 crore over the last month. Even otherwise, encouraging more investments by FIIs in government debt was never a sustainable of way of bridging the CAD, because the interest payment on the borrowings would leading to more dollars flowing out of the country.
What policy makers will now have to focus on are concrete measures to bring down the import bill and a long term strategy to boost exports.
Excerpts from a report by brokerage house Kotak Securities in January this year.
"India's export strategy primarily revolves around tax incentives for exports. There is very little focus on fixing the input and output markets, reducing cost of capital and reducing corruption. We do not see how India's exports can improve dramatically without addressing all aspects."
On import front, the government has been taking steps to curb oil imports by gradually hiking domestic fuel prices, and also to deter gold consumption through a combination of higher duties and policy curbs that increase the cost of importing gold.
But there is much more to be done to reduce the import bill meaningfully.
According to Kotak Securities, the thrust will have to be reducing imports or items that can be easily produced in India and managing the demand and supply of items (energy, for example) that India does not produce in sufficient quantity.
"India's energy imports will explode over the next few years. We believe the energy situation can be managed better through proper exploitation of its vast coal reserves and large hydro-electricity potential. We think it is quite appalling that India imports coal despite sitting on the world's fifth largest coal reserves."