The challenges policymakers face in managing the external economy have been increasing recently in the face of a marked deterioration in several leading sectoral indicators. Two sets of data released by the Reserve Bank of India and the Finance Ministry at the end of last year show the extent of deterioration. The RBI’s report on India’s balance of payments during the second quarter (July-September 2012) pegs the current account deficit as a percentage of GDP at an unprecedented 5.4 per cent, up from 4.2 per cent a year ago. The widening merchandise trade deficit — the fall in exports being greater than the fall in imports — compared to the previous year is one obvious reason. India’s exports have been declining month after month, as the prospects of a revival in the principal markets of the developed world have not improved. Imports of two commodities, gold and petroleum, have remained sticky and account for a substantial portion of the imbalance. Various measures adopted by the government and the RBI to curb the demand for gold have had limited success. Past experience suggests that measures such as physical controls will be counterproductive and encourage illegal trade. One promising route, though relevant only for the long term, is to popularise gold-based financial products to wean away consumers from their old preference for gold.
The widening trade deficit is obviously not the only problem. Growth in private transfers, notably remittances, has been weak, increasing by just 2.9 per cent in the second quarter of 2012-13 compared to over 20 per cent in the corresponding period last year. In the past, these and earnings from software exports have cushioned the trade deficit. Their marginal growth has once again exposed the external sector to a dangerous dependence on short-term inflows from foreign institutional investors and portfolio managers who can exit just as easily as they have been coming in recently. Mistaken government policies are partly responsible for the big jump in India’s external debt to $365.20 billion as at end-September, up by nearly $20 billion from a quarter earlier. The Finance Ministry report attributes the increase to higher non-resident Indian (NRI) deposits, short-term debt and external commercial borrowings. In the past, the authorities have actually discouraged these forms of financing, in fact providing disincentives. More recently however, won over by expediency, a short-sighted government has veered to the other extreme, for instance assuring NRIs of high returns and reducing the withholding tax on external borrowings. The sharp rise in short-term foreign currency debt is an ominous development. Bunched up repayments will pose a serious threat to macroeconomic stability in the future.