Don't expect CAD to spark big reaction on Re: Nomura

India’s current account deficit (CAD) rose sharply to 6.7% of GDP in the October-December quarter compared to 5.4% in the last (July-September) quarter.

In an interview to CNBC-TV18 Neeraj Gambhir, managing director & co-head, fixed income India, Nomura India, and Shubhada Rao, chief economist, Yes Bank discussed the causes and consequences of the rise of the greater evil of India’s twin-deficit dilemma. Rao feels that one negative surprise this time are low remittances, which are typically much more as the October-December quarter sees much larger remittances on account of festive-related spending being sent back. According to Gambhir, one should not expect a severe impact on the Indian currency due to CAD. "The market was prepared for a large negative number, it is not that much of a big shock. The real issue for rupee would be what is the trend in the flows going forward," he added. But on the whole, both experts find the trend quite disturbing. The steadily growing CAD is getting financed by debt capital, the funding of which leads to further outflows in the form of interest, which may worsen India’s CAD.  Below is the edited transcript of Rao and Gambhir's interview to CNBC-TV18. Q: Is Q3, current account deficit (CAD) more shocking than you thought? Rao: Yes, it is about a gap of USD 1.5 billion from our estimate. We had estimated USD 30.9 billion. So, USD 32.5 billion has come in. On the invisible side, the negative surprises are on the remittances. This is a bit surprising because typically, October-December quarter sees much larger remittances on account of festive-related spending being sent back. So, that is one of a negative surprise. Broadly, other heads of current account have been in-line with what we were expecting. However, trade deficit at close to USD 60 billion for the quarter probably is the worst. Q: What do you think is a long-term negative in the numbers that you saw fall in private transfers? Or the rise in investment income payments that we are forced to make, what is the disturbing number in the current account basket? Gambhir: The fall in private transfers is a negative surprise, but I would wait for a couple of more data points to see if it is actually a trend change. As far as the other components are concerned, it is not so much of a negative surprise but the trend clearly is quite disturbing that we have a steadily growing current account deficit (CAD) which is getting financed by debt capital. As the financing of the debt capital leads to further outflows in the form of interest, it steadily worsens the CAD. That is a fundamental structural issue with our CAD at this point in time. Q: Since you would be in touch with a lot of people who invest in India, this 2.5 billion of foreign direct investment (FDI) inflow is also some kind of a near-term low. I can’t remember when we last saw such a low number. Going back in the last four quarters, we have not had a number as low as 2.5 billion on FDI. Is that a long-term negative or should we not comment now because these are lumpy things and it could be a one quarter thingy? Gambhir: As far as FDI is concerned, the structure of Indian economy is such that traditionally, we have had a much larger component of foreign institutional investor (FII) flows as compared to FDI flows. There is also a little bit of a definitional issue here as to what exactly does one call FDI. If somebody invests in the secondary market, is it FDI even if it is a long-term investor? So, there is a bit of a definitional issue that got touched upon in the last Budget of the Finance Minister and the government is now working to resolve exactly what is called FDI. _PAGEBREAK_ We are heavily dependent upon foreign capital whether that comes in the form of an FII investment or comes in the form of an FDI investment. The concern would be that the component of debt is increasing and that is clearly not a very good long-term financing strategy. We should see more component of equity FII flows or FDI flows. Q: Any comments on the capital flows? The foreign institutional investment is  predictably good. The Finance Ministry’s ideas for future financing also seem to increase the FII limit on debt, equity. Would you worry? Rao: Yes, to an extent definitely there is worry because it eats into the country’s current account invisibles’ income. We have to service our debt and that’s exactly getting reflected in the negative investment income. From USD 3-4 billion we are seeing the number increasing from USD 5-6 billion to USD 7 billion. On foreign direct investment (FDI), the last two or three quarters we did hear a lot of domestic producers actually talking of shifting their base to outside India because of the policy hurdles and other issues. That is actually now getting reflected on outward FDI and as a consequence on the net FDI numbers. So, as the policy improves we will not see the extent of outflow on account of domestic policy issues. Quite clearly, it is very important how we finance our current account gap. Let’s not forget, we are looking at about USD 60 billion now. The current account gap coming below four percent, even going into FY14 would remain a bit of a challenge and that is tantamount to think that we need atleast USD 85-95 billion band of capital flows. So how is it financed? Hopefully through equity, domestic diasporas – non-resident Indian (NRI) deposit, but as long as FIIs in corporate investment are productive, then its good. Otherwise, there would be concerns on the mode of financing of the current account gap. At the end of the day it all boils down to how we are improving our macros to keep our trade deficit narrower. We need to look at the structure of the CAD, which is getting weaker over the last four or five quarters. That is the reason there is a desperate need for USD 85-95 billion year-after-year. We definitely need an improvement in domestic macros for global investors to remain attractive to India as investment destination. Q: This year it might be more? Already in April-December the current account gap is USD 72 billion and this was our annual gap last year. This time, it is already in the nine months. So, we could perhaps get into USD 95 billion or thereabouts. Will the rupee react now because we were mentally prepared for 6.4 percent, this is still a lagged number. Do you think Monday would set a cat among the pigeons? Gambhir: I don’t think it should spark a big reaction in rupee. Obviously some negative sentiment would prevail, looking at the actual data. However, to the extent that market was prepared for a large negative number, I think it is not that much of a big shock. The real issue for rupee would be what is the trend in the flows going forward. Traditionally, the last quarter is a strong quarter in terms of flows. But what happens as we get into the next quarter in terms of flows, the impact of the global risk sentiment towards emerging markets in general and towards Asia, these are all very important factors as far as the flows are concerned. With USD 90 or USD 95 billion of current account deficit, obviously, you need that much of flows to come into the country. Anything which impacts the sentiment negatively, whether it is the global economic environment or the event driven news such as Cyprus through the last two weeks, does impact flows and that is what is important. The market is somewhat aware of it and it has somewhat priced it in.

Q: Any last thoughts before we wind up? Rao: For the next quarter, we will see some payback on account of gold because of the festival season. That is also a big indicator. Secondly, for the next year we have to keep in mind that if there is any impact of the revival in the global growth, particularly in US on our exports, that is the important factor to watch out for.