It’s not just that the current account deficit is widening—the means of financing it also became more risky in 2017-18. On the one hand, higher oil prices are raising the current account deficit and on the other, foreign direct investment—the most stable source of financing the deficit—has come down. This has led to greater reliance on foreign portfolio inflows, particularly volatile debt inflows and also on short-term credit.
This is a problem because the US Federal Reserve has been raising interest rates and has signalled more rate hikes to come. As RBI governor Urjit Patel wrote in an article in The Financial Times, the US Fed’s programme of shrinking its balance sheet, coupled with increased US Treasury issuance to fund a larger government deficit, has already led to dollar liquidity shrinking in international markets, particularly in the debt markets. This is behind the outflows from emerging market debt. Read More
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