After several years of current account surpluses and growing reserves, the investment recovery and consumption boom have pushed the external current account into deficit. In 2004/05, the trade deficit widened to over 5½ percent of GDP and the current account reverted into deficit for the first time in three years, notwithstanding high growth in services income. While export growth continues to be strong, a large increase in both oil and non-oil imports caused the trade deficit to widen further this year, and contribute to a sharp deterioration in the current account deficit. Staff projects it to reach 3 percent of GDP in 2005/06.
The balance of payments position remains comfortable with strong capital inflows helping finance the growing current account deficit. In 2004/05, close to half of all capital inflows were debt creating, as Indian corporates took advantage of favorable global interest rates, an appreciating rupee, and the liberalization of restrictions on external commercial borrowings to borrow abroad. While portfolio flows have continued to gain importance, FDI inflows remained weak. So far this fiscal year, capital inflows have remained strong and reserves have only fallen modestly as a result of the redemption of the India Millennium Deposits. While more reliance on debt and portfolio inflows has increased India's susceptibility to changes in investor sentiment, ample reserves and remaining capital controls limit risks of potential reversals.
Asset markets have strengthened. Net foreign investor inflows have accelerated since mid-2005, as equity prices soared. Equity prices are up around 50 percent from end-April. Ample liquidity and historically low interest rates also helped fuel property prices, which have risen in major cities by over 20 percent annually over the past two years. Concerned with speculative pressures, the RBI has raised risk-weights on housing and real estate loans and imposed controls on real estate investments aimed at curbing speculative FDI inflows.
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