Describing the external sector as the ‘biggest threat’ to macroeconomic stability, the Reserve Bank on Tuesday urged the government to take immediate steps to narrow the current account deficit, which has hurt the rupee and overall growth.
"The biggest risk to the macroeconomic outlook stems from the external sector," RBI Governor D Subbarao said while unveiling the first quarter review of the monetary policy.
The RBI left key policy rates unchanged and cut the GDP growth estimate for this fiscal to 5.5 per cent from 5.7 per cent.
The large CAD, well above the sustainable level of 2.5 per cent of GDP for three years in a row, is a formidable structural risk factor, the RBI said in the review.
The Governor urged the government to act swiftly to tackle the problems posed by the high CAD, cited as a major reason for the rupee's over 10 per cent decline this fiscal.
The recent measures by the Reserve Bank to restore stability to the foreign exchange market should be used as a window of opportunity to put in place policies to bring the CAD down, the central bank said.
"It should be emphasised that the time available now should be used with alacrity to institute structural measures to bring the CAD down to sustainable levels," Subbarao said, adding the central bank is ready to do its bit.
The CAD, which widened to an all-time high of 4.8 per cent of GDP in FY13, has brought the external payments situation under increased stress, reflecting rising external indebtedness and the attendant burden of servicing of external liabilities, it said.
In its macroeconomic report yesterday, the RBI said ebbing of the CAD in Q4 of the last fiscal will not be sustained in Q1 of this fiscal due to increasing imports of gold and coal, apart from rising crude prices.
Given the wide CAD, the RBI urged the government to adjust administered prices in the energy sector and pass on increases to consumers to help keep fiscal deficits under check.
The RBI has tightened liquidity to curb forex speculation. It also introduced steps to restrict gold imports, which have put pressure on the CAD.
Most external vulnerability indicators have deteriorated, eroding the economy's resilience to shocks, said Subbarao, who is because of demit office in the first week of September.
Growing vulnerability in the external sector reinforces the importance of "credible fiscal consolidation" with accent on both quantity and quality of adjustment, he said.
In its policy-eve Macroeconomic and Monetary Developments First Quarter Review 2013-14, the RBI expressed hope the CAD would moderate in the current financial year.
However, the central bank said volatile markets and the potential tapering of quantitative easing in the US pose a risk to CAD financing.
External sector policies should be carefully calibrated over the short to medium term to contain the CAD within manageable levels and finance it through more stable flows, it said.