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CAD falls! What does it mean to you and your investments?

A high level of CAD was a big drag for foreign portfolio investors, which have been a key driver of the domestic asset classes, especially equity, over the past several years.

June 14, 2015 11:00 IST | India Infoline News Service
A nagging worry of the Indian economy current account deficit seems to getting over. RBI on Wednesday said India's current account deficit narrowed to 0.2 per cent of gross domestic product in the January-March quarter, its lowest in a year, as global oil prices slumped while foreign investments into the country remained robust.

That marks a stark turnaround from the record high of 4.8 per cent of GDP registered in financial year 2012-13, which brought on India’s worst currency crisis in more than two decades. While it spells great for the broader economy, it also means a lot from an investor’s point of view.

First of all, high current account deficit tends to put downward pressure on the exchange rate, leading to currency volatility. With the drop in CAD, investors can expect the rupee to be a little more stable now, even though external factors will continue to keep their pulls and pressures on the domestic unit.

A high level of CAD was a big drag for foreign portfolio investors, which have been a key driver of the domestic asset classes, especially equity, over the past several years. FPIs tend to avoid emerging markets in times of high currency volatility and when macro economic indicators point to risks to growth in the economy.

Foreign inflows into India's debt and equity markets surged to $12.9 billion during January-March, up nearly 36 percent from the same period a year ago, stoked by continued optimism about the prospect of economic reforms. It is foreign flows which would eventually determine the outlook for the country's current account.

A high current account deficit, which indicates higher imports, usually leads to a drop in manufacturing and services, leading to lower growth, which also means slower growth in incomes and savings, leading to a slump in asset prices.

A high current account deficit can also mean a reduction in inflationary pressure, as there will be a fall in aggregate demand, which will invariably results in lower topline and bottomline expansion for companies, thus slower rise in stock prices.

On the other hand, a lower CAD gives the government more breathing space, more room to invest in asset creation (read creation of infrastructure), leading to faster growth in the economy, and thus in jobs, incomes and asset prices.

In this particular instance, investors who have a knack for investing in gold may look for better times ahead and the government may eventually further ease the curbs on gold imports, leading to better demand for the yellow metal, bringing it out of the current phase of sluggishness.

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