ET Graphics: BoP stability tested by outflows & Rupee fall
India's external accounts are under strain. The current account deficit is widening, and capital may flow out. The rupee has weakened significantly. Policymakers are considering various measures beyond interest rate hikes to stabilize the currency. These include incentives for foreign deposits and liberalizing capital inflows. State-owned banks may also issue foreign currency bonds.
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Context
India's Balance of Payments (BoP) stability is currently facing stress due to significant foreign capital outflows and a depreciating Rupee. Economists suggest the may need to deploy unconventional policy measures, beyond standard interest rate adjustments, to stabilize the currency and attract foreign inflows. These measures could include reopening currency swap windows, incentivizing non-resident deposits, and encouraging foreign currency bonds.
UPSC Perspectives
Economic
The core issue highlighted is the pressure on India's Balance of Payments (BoP), a systematic record of all economic transactions between residents of a country and the rest of the world. The BoP has two main components: the Current Account (trade in goods, services, and transfers) and the Capital Account (foreign direct investment, foreign portfolio investment, and loans). The article indicates that while the Current Account Deficit (CAD) is widening, the more significant concern is the shrinking Capital Account surplus. When capital outflows exceed inflows, it puts downward pressure on the domestic currency. The manages this through its exchange rate policy. India follows a managed float system, where the intervenes in the foreign exchange market to prevent excessive volatility. In this scenario, the Rupee's fall signals a tightening BoP situation, necessitating proactive policy responses to maintain macroeconomic stability.
Monetary Policy & Banking
To counter the Rupee depreciation, the has conventional and unconventional tools. Conventionally, raising the Repo Rate (the rate at which the RBI lends to commercial banks) can attract foreign capital seeking higher yields, thereby supporting the Rupee. However, the article emphasizes unconventional measures. One such measure is reopening a currency swap window for Oil Marketing Companies (OMCs). OMCs need large amounts of dollars to import crude oil. By providing them dollars directly in exchange for Rupees, the reduces the demand for dollars in the open market, easing the pressure on the Rupee. Another strategy involves incentivizing deposits. These are term deposits made by Non-Resident Indians (NRIs) in foreign currencies. Offering higher interest rates or other incentives on deposits can attract stable foreign currency inflows, boosting the 's foreign exchange reserves and providing a buffer against external shocks.
Governance
The suggested policy measures highlight the critical role of the and the government in macroeconomic governance. The proposal to remove the withholding tax for foreign investors in sovereign bonds is a fiscal policy tool aimed at making Indian debt more attractive. Withholding tax is a tax deducted at source on income earned by non-residents. Removing it increases the net return for foreign investors, potentially increasing inflows into the Indian debt market. Furthermore, the idea of allowing Public Sector Banks (PSBs) to issue foreign currency bonds on a hedged basis demonstrates how state-owned entities can be leveraged to raise capital abroad. This strategy, however, requires careful management of currency risk. If the Rupee depreciates further, the cost of servicing these foreign currency bonds will increase for the PSBs. Therefore, effective governance involves balancing the need for immediate capital inflows with long-term financial stability and risk mitigation.