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Saturday, April 6, 2013

India’s worsening Current Account Deficit: Where it points its Finger?

India has recorded the worst ever current account deficit at 6.75% of GDP for the quarter ended December 2012. In absolute terms, the CAD stood at $32.6bn against $20.2bn in the same quarter of the last year. For the last nine months, India ended up with a CAD of 5.4% of GDP, up from 4.1% of GDP for the corresponding period of the previous year. If there is anything like solace in this grim scenario, it could be said of the Balance of Payment position ending up in a positive territory.

The rest is all stressful: the growth in GDP has fallen in the quarter to 4.5%, merchandise exports didn’t show any significant growth, while on the other hand imports grew 9.4%, largely on account of rise in import of oil and gold. Nor does the external environment anyway encouraging: Europe is still struggling to clean up its financial mess capped by the latest Cyprus banking debacle while growth in the US economy is still elusive.

The huge current account deficit is certainly a pointer towards severe shortage of domestic savings.  And over it this deficit that is being financed by the FIIs is certainly not going to generate additional capital revenues in the days to come so that we could as well  service the present current account borrowings. So long as the CAD is financed by the fickle minded global portfolio investors, our economy remains vulnerable. All this is pretty scary to think of!

One argument that the government is often found to come up with is: the present worsening CAD is more due to huge imports of gold. But what must be remembered here is not the people’s fetish for gold but the policy of the Central Bank and the government’s fiscal policies. In its anxiety to give a fillip to the sagging economy to grow, of course, at the nudging of the government, the RBI has adopted a low interest rate policy resulting which, real interest rates in the country have been negative for almost last three years. In such a situation it is silly of intellectuals to expect domestic savers to keep their savings with banks. So, the only alternative that is known to give appreciation beside being a value of store, domestic savers are resorting to gold hoardings, which the policy makers cannot find fault with.

The other known evil of low interest rate regime anywhere is: people borrow more and tend to spend more. Else it would get translated into higher prices in the domestic market. Obviously, it is this tendency of people to spend more is what now got translated into more imports—more of gold and oil. But India being what it is, we are facing an unusual phenomenon: high inflation along with high imports—a double whammy. There is of course, a reason behind it: High growth in GDP, that too, confining to a small segment of the population, which is engaged either in spending on luxuries—sudden spurt in acquisition of vehicles and the resulting increased demand for oil consumption/increased import bill under oil—or looking of alternative investments to bank deposits to beat the negative returns that has resulted in the double whammy. Yet, the government could not resort to market determined oil prices.  So, an unattended distortion had only added fuel to fire. 

Another unintended consequence of lower interest rate regime is that foreign debt flows tend to dry out on account of narrowing interest rate differential, which means its financing has to be either through other Forex flows, such as FDI of Flows into stock market. We have been experiencing sharp fall in FDIs, while the RBI Governor hopes that the equity flows may continue to grow as investors “see in this [fall in interest rates] a signal of lower inflation and a better investment environment”.  But FII s are the most undependable lot for any day, suddenly  becoming risk-averse or owing to the financial constrains that they might face in the global financial markets can desert Indian market all at once. Indeed, that’s what the Governor of the RBI echoed in his LSE Speech, when he said: “A CAD above the sustainable level, year after year, is a clear macro economic risk as it raises concerns about our ability to meet our external payment obligations and erodes the confidence of potential lenders and investors.”

So living beyond one’s own means is always a dangerous proposition—nothing new in it. Yet, there are people who argue that things are different this time. For instance some analysts argue that so long as the high CAD /GDP ratio can be financed by fresh inflows, there is nothing wrong with it—nothing to worry about! Secondly, they say this time round there is no debt repayment problem—the external debt stock/GDP is 19.7% as against 28.7% in 1990-91. Similarly debt service ratio is also pretty low now at 6% as against 35.3% during 1990-91. Hence people argue the things are different and even stretch their argument further saying, “India is an exception”. 

But in all this analysis of CAD and its cons, many analysts are missing to take cognizance of a recent but very important development in Indian economy: Outflow of capital from India to overseas markets in the form of acquisitions. Is it a FDI of India or flight of capital from the country in want of encouraging policies for investment? Indeed, Kumarmangalam Birla, Chairman of Aditya Birla Group aired his displeasure at the investment environment in the country.   In either case, we must remember, it is depriving the country both, scarce foreign capital and the opportunity to create fresh employment, that too, in great numbers in the production sector. Time, we pay attention to this new development where billions of Indian capital being invested outside its territory.

The entire discussion on CAD ultimately points to the government policies regarding fiscal profligacy, for once the macroeconomic ills are cured, CAD problem is automatically solved. So, political leadership of the nation should rise to the occasion, as indeed the governor of the RBI observed in his LSE speech: “The India growth story is not inevitable. It will not materialize in the absence of vigorous and purposeful structural and governance reforms. It is those reforms that must continue to engage our attention.” 

Now the question is: elections being at the door-step, who will attend to these urgencies/reforms?


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