High CAD is bad for you

Last Updated: Fri, Apr 05, 2013 10:29 hrs

Investments, education and travel abroad will be more expensive

Travelling abroad might not be the best of ideas this year. The high current account deficit (CAD) - 6.7 per cent of gross domestic product in the third quarter - means the demand for dollars will continue to be high, and more important, the downward pressure on the rupee is likely to continue. Similarly, the cost of education for children studying abroad will be higher and if you are investing in stocks abroad, returns will suffer.

Why? In August 2011, you were paying Rs 45 to buy one dollar, whereas now it is almost Rs 55 - a fall of Rs 10 or 18-20 per cent in one-and-a-half-years. In other words, more rupees are being used up to buy the same dollar, thereby adversely impacting your return from investments and higher cost of travel and education abroad.

But if one goes by experts, a high CAD is not just bad for global travel or education; it might even discourage the Reserve Bank of India (RBI) from cutting the repo rate aggressively. "The central bank cannot ease policy rates till CAD comes in control. Hence, existing borrowers will have to continue paying high rates and new borrowers may want to wait. Today, inflation is not the only criteria for lowering rates," explains Rupa Rege Nitsure, chief economist at Bank of Baroda.

Of course, a high borrowing rate means even deposit rates might not fall sharply. So, fixed deposits might continue to attract investors. "Those investing in fixed deposits and debt mutual funds can expect stable rates for sometime, as a high CAD will not allow RBI to lower rates drastically," says Abheek Barua, chief economist of HDFC Bank. CAD is the gap between the inflow and outflow of foreign funds in a country. It hit a high of 5.4 per cent in the second quarter and climbed to 6.7 per cent in the third quarter of 2012-13.

As a natural consequence, the outlook on equities is not great if deposit rates continue to remain high. Retail and high net worth individuals will continue to rely on debt or innovative instruments, instead of equities. What is good is that the high CAD has been supported by capital inflows from foreign institutional investors (FIIs), foreign direct investment and external commercial borrowing. But Barua says if the capital inflows are impacted adversely and FIIs were to pull out of the market, there will be high volatility.

This would become risky for investors. Capital inflows in the Indian markets are in debt products for high yields. To attract funds, RBI also increased the FII limit in corporate bonds and government securities by $5 billion each, taking the total cap in domestic debt to $75 billion (Rs 412,500 crore). Madan Sabnavis, chief economist, CARE Ratings, advises that investors be cautious with investments in such times.

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