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CAD: the danger is real

C. R. L. Narasimhan
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The news of India’s current account deficit (CAD) touching a record 6.7 per cent of gross domestic product (GDP) ($32.6 billion) in the third quarter of fiscal 2012-13 (October-December 2012), up from 4.4 per cent ($20.2 billion) last year, need not have surprised policymakers. That is because all economic trends have pointed to a rise, although the magnitude was clearly beyond comprehension. Despite this, however, there have been very few worthwhile policy responses. All that the Prime Minister and other important government spokespersons can say is that they expect the deficit to go down in the last quarter (January-March 2013) and end the year somewhere just above 5 per cent, still high but not alarming.

Silver lining

Senior Finance Ministry officials even see a silver lining even in this bleak scenario. After all, the CAD, though high, has been funded through capital inflows and not through a drawdown of reserves. In fact, there has been a small accretion of $0.8 billion to the reserves, as against a decline of $0.22 billion in the previous quarter (July-September 2012).

Such comforting words notwithstanding, it has to be realised that the CAD is unacceptably high, far higher than what the Reserve Bank of India (RBI) and other official forecasters say it should ideally be in the present circumstances (between 2.5 per cent and 3 per cent of GDP).

Besides, the official explanations do not in any way minimise the structural risks arising out of a grim trade scenario and dependence on short-term capital inflows to bridge the deficit. The CAD, defined broadly as the excess of the country’s total imports of goods and services and transfers over the total imports under those categories, has seldom caused so much as concern as now. Another way of estimating the CAD is to calculate the merchandise trade deficit plus or minus ‘invisibles’ and net earnings from services (such as software exports and financial services).

Merchandise trade deficit

The primary reason for the widening of the CAD is the large merchandise trade deficit. Merchandise exports have been flat in the third quarter. On the other hand, merchandise imports were up by 9.4 per cent, spurred largely by imports of gold and silver. Trade deficit widened to $59.6 billion in Q3 of 2012-13 from $48.6 billion over the same quarter in the previous year. During the period under review, net services receipts recorded a modest increase of just over 9 per cent and net invisibles moderated. These two categories have traditionally helped in the balance of payments (BOP); their lacklustre performance has added to the pressures.

All the above once again point to a dangerous dependence on short-term capital flows to finance the deficit. According to the RBI, the pick-up in capital flows was mainly due to foreign portfolio investments, which rose to 8.6 billion during Q3 of 2012-13, up from $1.8 billion in the previous year. Loans availed by banks and corporate sector amounted to $7.1 billion. Foreign direct investment, by far the more desirable of investment flows, declined to $2.5 billion in Q3 of 2012-13 from $2.5 billion a year earlier.

In a strategy based on expediency rather than on sound judgment the government has been doing all that it could to make the environment conducive for short-term flows, including, especially, those going to the stock market. These could well backfire. In many cases the government has performed a U turn to encourage such flows, which previously they had tried to discourage.

Important message

The most important message from the BOP data for Q3 of 2012-13 is this. The dependence on short-term, volatile portfolio flows indicates a degree of helplessness. It is not policymakers do not discern the consequences. Such flows, essentially fuelled by ultra-loose monetary policies of the West, could just as well reverse for any number of reasons, only a few of which are in India’s control.

Again, a revival in exports depends on the economic conditions in Europe and the U.S. There is not much India can do. The trade policy due in the first week of April has been postponed by a few weeks amidst report of differences between the commerce and finance ministries over the quantum of financial incentives for export promotion.

narasimhan.crl@thehindu.co.in


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