Amid the generally bleak economic scenario, two recent news items should provide some relief to the government. The narrowing of the current account deficit (CAD) to $31.1 billion (2.3 per cent of gross domestic product (GDP)) during the first-half of the year (April-December 2013) from $69.8 billion (5.2 per cent of GDP) during the same period in the previous year is nothing short of spectacular — so worried were the policy-makers at this time last year that the burgeoning CAD was listed as the number one economic problem, which also did not appear to have any easy solution.
The other piece of good news relates to inflation which has remained persistently high. The good news is that both CPI (Consumer Price Index) inflation (retail inflation) and WPI (Wholesale Price Index) inflation eased substantially in February. Retail inflation declined for the third straight month to a 25-month low of 8.10 per cent. WPI inflation touched a nine-month low of 4.68 per cent in February, down from 7.28 per cent in the previous year and 5.50 per cent in January 2014.
Both these are significant news and are on the face of it, extremely positive for the economy. The widening current account deficit, not so long ago a bugbear, appears eminently manageable. In fact, BoP data for the third quarter showed CAD at $4.1 billlion, the lowest in 19 quarters. The current financial year might well end with a deficit of around 2 per cent.
In sync with the impressive fall in the CAD, the rupee has been stable. Foreign capital flows have been coming in strength and there is no threat to external reserves which have remained stable. Can there be a contrary view? Perceptive analysts do not discount the achievement but are not so sanguine about the ways in which the CAD has been brought down.
The arguments are familiar. The reduction in the CAD is mainly due to a severe clampdown on gold imports through tariff and non-tariff measures. During each of the past eight months, gold and silver imports contracted at an average of nearly 70 per cent a month. For the first 11 months, India’s gold and silver imports, on a cumulative basis, stood at $30.53 billion. That is more than 40 per cent lower than the $52.47 billion of imports over the same period in the previous year. Consequently, during the same period, India’s trade deficit fell by nearly 29 per cent to a little over $128 billion from over $179 billion. That, in turn, brought about a reduction in the CAD.
Inevitably, on the negative side, there has been a spurt in gold smuggling with its attendant deleterious consequences. The government loses revenue which would have accrued if the trade had remained above ground. Smuggling has major implications for law and order. Hawala trade has revived. Besides, India’s considerable exports of jewellery have been hit by the clampdown on gold imports.
Turning to the favourable trade balance, it must be remembered that it has occurred not by the ideal way of increased exports. In India, exports did stage a smart pick-up but recently have slowed. Imports — non-gold, non-oil — have declined but that is not a good sign as it is an indication of the slowdown. In short, the CAD contraction has occurred due to a rigorous curtailing of gold imports. Exports need to go up on a sustained basis but fall in imports is not at all positive.
On the inflation front, policy have earned a much-needed respite but does it give any leeway to the Reserve Bank of India (RBI) to reduce interest rates when it presents its credit policy statement on April 1?
Despite the appreciable fall, retail inflation is still high. Inflation expectations remain high consequently. Besides, the fall in inflation is almost entirely due to a sharp fall in vegetable prices. This was anticipated by the RBI much earlier. The possibility of vegetable prices going up cannot be ruled out. Reports speak of unseasonal rains in some important vegetable producing States.
Importantly, the RBI is shifting monetary policy anchor to retail inflation in line with the Urjit Patel Committee’s recommendations. Moreover, core inflation — non-food, non-fuel manufactured inflation — has been going up steadily. This is a widely watched measure of inflation.
In the present context, all these indicate maintenance of a status quo by the RBI on April 1.
The above analyses recognise the fact that there is a flip side to any major development. Reduction in the current account deficit is of great significance but it has come about through a drastic compression in imports of gold. News on the inflation front should bring cheer but there is a possibility that the seasonal decline in vegetable prices might reverse.
Foreign capital flows have been coming in strength and there is no threat to external reserves which have remained stable.