Moody's, which has a stable outlook for the Indian economy, cautioned that setting CAD target on assumption of acceleration in economic growth "are more likely to be missed".
"Policies that trigger private investment and curb inflationary pressures in the near-term are more likely to help narrow the account deficit...," Moody's Investors Service said in its report.
"... deficit targets based on an assumption of accelerating growth rates are more likely to be missed, leading to higher government borrowing requirements and likely inflationary pressure, both of which have negative implications," it said.
The CAD, which is the gap between the inflow and outflow of foreign currency, has been widening on account of higher volumes of gold and oil imports. CAD stood at 4.2 per cent of the total GDP in 2011-12 financial year.
"In addition to further policy reforms, it is the execution of policies that will determine how export and import growth evolve," Moody's said.
The trade deficit in January widened to USD 20 billion in January, the second highest rise ever in a month. The biggest trade gap of USD 21 billion was recorded in October, 2012.
The government has already taken a host of reform initiatives including liberalising FDI norms for various sectors, to increase foreign investment flows into the country. Besides, it has also liberalised the norms for external commercial borrowings.
Moody's said it would also monitor whether the policy changes shift the composition of India's CAD financing in favour of foreign direct investment (FDI), or whether external debt inflows accelerate faster than investment flows.
"If funding for the CAD shifted away from external debt and towards foreign direct investment, the sovereign credit profile would benefit," it said.
It added that inflationary pressures could resurface because of recent fuel price hikes or pick up in food prices.
The WPI inflation in January was at a three year low of 6.62 per cent.
"Higher domestic inflation affects the current account in several ways: it makes exports more expensive, imports cheaper and interest rates higher. Therefore, should high inflation and elevated domestic capital costs decline over 2013, they may benefit the current account," Moody's said.
Moody's has a 'Baa3' rating for India with a stable outlook.
Domestic thrust key to lowering current account deficit: Moody's
(Reuters) India will have to pursue domestic policy initiatives to help achieve any near-term improvement in its current account deficit as global growth may only be slightly better in 2013 and commodity prices are unlikely to ease sharply, Moody's Investor Service said.
While recent government moves to cut subsidies and woo foreign investment would help narrow the external deficit, these policies need to be persisted for any significant success, it said in a note dated February 14, issued just two weeks before India's annual budget on February 28.
India posted its second highest ever monthly trade deficit of $20 billion in January as imports surged to record highs, piling pressure on a widening current account deficit and limiting scope for the central bank to cut interest rates for an economy expanding at its slowest pace in a decade.
The current account deficit hit an all-time high of 5.4 percent of gross domestic product in July-September due to slowing exports and heavy oil and gold imports. The gap is expected to widen further in the subsequent quarter, data for which is due in March.
Moody's said it would be watching the assumptions underlying India's budget deficit target for the new fiscal year that begins on April 1, as well as the expenditure and revenue policies announced in order to meet that goal.
"Policies that trigger private investment and curb inflationary pressures in the near term are more likely to help narrow the account deficit," it said.
"Deficit targets based on an assumption of accelerating growth rates are more likely to be missed, leading to higher government borrowing requirements and likely inflationary pressure, both of which have negative implications."
The rating agency will also monitor whether the policy changes shift the composition of current account financing in favour of foreign direct investment, or whether external debt inflows accelerate faster than investment flows.
"If funding for the current account deficit shifted away from external debt and towards foreign direct investment, the sovereign credit profile would benefit," it said.
Moody's has a Baa3 rating for India with a stable outlook.