India Funding Strain Grows as Fed Outlook Hurts Rupee

India faces growing strain to fund the widest current-account deficit in major Asian nations after the rupee slid to an all-time low on concern the U.S. will curb monetary stimulus as its economy improves.

The deficit narrowed to $21 billion last quarter, from $32.6 billion or a record 6.7 percent of gross domestic product in October to December, the median of 10 estimates shows in a Bloomberg News survey before data due June 28. The Reserve Bank of India estimates the sustainable level at 2.5 percent of GDP.

The rupee touched the weakest level versus the dollar on June 20 after Federal Reserve Chairman Ben S. Bernanke said the U.S. central bank will probably taper bond purchases this year if the American economy performs as it projects. The potential for reduced stimulus exposes emerging nations from India to Indonesia and Brazil to the risk of capital outflows.

“The prospect of the U.S. unwinding stimulus means that funding the shortfall will get more challenging,” said Sonal Varma, an economist at Nomura Holdings Inc. in Mumbai. “Even if the deficit narrows, it will remain too high for comfort.”

The rupee, which touched an all-time low of 59.98 per dollar last week, fell 0.7 percent to 59.675 at the close in Mumbai. The S&P BSE Sensex index retreated 1.2 percent, while the yield on the 8.15 percent government bond due June 2022 rose to 7.70 percent from 7.62 percent on June 21.

The currency’s 9 percent tumble this quarter is the worst in Asia, according to data compiled by Bloomberg. India is prepared to take action to reduce volatility as needed, Raghuram Rajan, the top adviser in the Finance Ministry, said June 20.

Biggest Risk

The imbalance in the current account, the broadest gauge of trade, is the biggest risk to an economy that grew a decade-low 5 percent in the year ended March, according to the Reserve Bank.

Foreign-direct investment in India fell the most in more than a decade last fiscal year, increasing reliance on stock and bond inflows to fund the shortfall.

Overseas investors have sold a net $2.1 billion of Indian bonds and bought a net $4.2 billion of stocks so far this quarter. That’s less than first-quarter fixed-income purchases of $2.3 billion and share inflows of $10.2 billion.

Imports of gold and crude oil, and subdued exports amid an uneven global recovery, have stoked India’s current-account gap.

The International Monetary Fund estimates the shortfall at 4.9 percent of GDP this year, compared with 3.3 percent in Indonesia and a surplus of 2.6 percent in China. India’s imbalance is the widest in Asian economies with GDP exceeding $100 billion, the data shows.

Dollar Strength

“While the deficit is expected to narrow gradually this year, the combination of rising U.S. yields and the potential rise of the dollar will mean that India will continue to face funding risks,” said Chetan Ahya, an economist at Morgan Stanley in Hong Kong.

India has boosted taxes on gold imports to tackle the current-account gap.

The government is also considering easing restrictions on foreign-direct investment in a range of industries to woo capital, according to Finance Minister Palaniappan Chidambaram.

Those steps are part of a nine-month policy push by Prime Minister Manmohan Singh’s administration to bolster growth and avert a credit-rating downgrade.

Other measures have included paring the budget deficit, loosening foreign-investment rules in the retail and aviation industries and easing caps and levies on purchases of local bonds by overseas investors.

Foreign Reserves

The trade deficit in the 12 months ending March 2014 “should be lower than last year” as gold imports moderate, Commerce Secretary S.R. Rao said in a June 18 interview.

The Reserve Bank left interest rates unchanged this month, snapping three straight reductions, and said inflation, growth and the balance of payments will determine monetary policy.

Currency reserves stood at $290.7 billion as of June 14, Reserve Bank data show, about 9.4 percent lower than an all-time high of $321 billion in 2011. They “provide a cushion” against shocks, Fitch Ratings said June 12, when it boosted the outlook on India’s sovereign rating to stable from negative.

Still, sustained intervention to steady the rupee amid the high current-account imbalance is a challenge as it depletes reserves, according to Yes Bank Ltd.

The currency won’t stabilize until the central bank is able to “recoup” foreign-exchange reserves, Bank of America Merrill Lynch said in a note, adding the monetary authority will try to “defend expectations” at 60 rupees per dollar for now.

“India’s current-account deficit reflects lopsided economic management that failed to address supply issues,” said Arun Singh, an economist at Dun & Bradstreet Information Services India Pvt. in Mumbai. “It will take some more time before calm returns.”

Elsewhere in Asia today, Taiwan’s unemployment rate in May was unchanged from April. Singapore reported a 1.6 percent rise in consumer prices last month from a year earlier, while Vietnam’s gauge advanced 6.69 percent in June.

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