The continued rise in India's current account deficit and external debt could increase the country's vulnerability to international financial volatility, warned global credit rating agency Moody's Investors Service.

India's current account deficit (CAD), which averaged less than one per cent of GDP in the first half of the 2000s, has worsened in the last few years, touching a recent peak of 5.3 per cent of GDP in the quarter ended September 2012.

CAD occurs when a country's total imports of goods, services and transfers is greater than its total export of goods, services and transfers, making the country a net debtor to the rest of the world. India's external debt, among others, comprises external commercial borrowings, short-term debt and NRI deposits.

According to Moody's recently released report, Credit Implications of India's Current Account Deterioration , India's domestic policies partly explain why its current account deficit has exceeded that of many similarly rated peers operating in the same global environment, even those that are similarly reliant on energy imports.

This rise in the current account deficit has largely been funded by foreign currency debt. Consequently, India's external debt has doubled since 2006 to about $365 billion in the third quarter of 2012. Still, India's external debt to GDP ratio of 22 per cent is relatively low compared to similarly rated countries.

Moody's, however, cautioned that should current balance of payments trends persist, the country's external liquidity position will eventually weaken.

The credit rating agency observed that since global growth and commodity price trends are unlikely to change significantly in the near term, whether India's external metrics improve or not will depend on policies efforts to limit the fiscal slippage and inflationary pressures that have contributed to external balances deteriorating.

Recent policy measures to reduce fuel subsidies, cut the fiscal deficit and allow greater foreign participation in various sectors could narrow the trade deficit and lower growth in external debt if the country curbs import demand, improves export competitiveness and attracts foreign direct investment inflows.

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