Financial Scene C.R.L. Narasimhan

The current account paradox

Recent trends in India’s current account and their impact on the balance of payments and the larger economy, present an interesting study. The current account deficit (CAD) is the difference between the sum total of imports and all outward remittances on the one hand and the sum total of all exports and inward remittances on the other.

An obvious observation from recent CAD data is that it is so comprehensively dependent upon external factors over which Indian policy makers have so very little control.

For instance, global oil prices have a large say on India’s CAD. The NDA government was fortunate in one important sense — the unexpected fall in global oil prices caused a reduction in the import bill and consequently in the extent of the deficit.

The reduction was particularly welcome. During the period 2011-13 the CAD rose from below three per cent of the GDP to above five per cent. This made India particularly vulnerable to shocks. The exchange rate of the rupee fluctuated violently and posed challenges to the RBI. Even before the American taper induced depreciation the Indian currency fell by 20 per cent. In the wake of the taper — the U.S. authorities announced the end of their ultra soft monetary policy — it lost another 20 per cent.

Thanks to some deft moves by the RBI and the imposition of quantitative restrictions on gold imports by the government, the rupee rallied during the second half of 2013-14.The rupee derived a lot of strength from the vastly improved sentiment that has come about with the change in the government. During the first half of the financial year, the positive trends continued. Petroleum prices continued to fall. The government seemed to embark on a series of reform measures. Pacts were signed with a number of countries. These promised more trade and a larger FDI investment. The logjam over coal appeared to be getting resolved with not a little help from the Supreme Court.

.A flurry of announcements seem to herald major banking sector reform. In short, the first year of the NDA government appeared to be extremely favourable for overseas investors. No surprise really that the foreign institutional investors contributing the bulk of foreign investment continued to patronise the stock markets .They were helped considerably by the continuance of ultra soft monetary policies by the U.S. Fed Reserve.

Stock markets lend gloss

Stock market behaviour needs to be analysed from many angles. A dispassionate analysis will throw up some factors that are negative and some positive. However, during most of the time the NDA government has been in office, the rise of the stock markets has had nothing to do with economic fundamentals or corporate results. The market's optimism has been based on flimsy optimism.

But for the balance of payments, the continued flow of FII investment has been good news. Puffed up market seemed to indicate all was well with the economy. The crucial dependence of the current account on short-term, volatile flows — which might reverse anytime — has once again been blithely brushed aside.

In short, the early months of the NDA government might have bred complacency. The window of opportunity that the government had to carry out the more difficult reforms might have been missed. Specifically for the external sector, the following developments are ominous:

Slipping over oil

One: Oil prices are up again. No expert is willing to hazard a guess as to how much higher they will go over the near term. The geopolitical situation remains fluid. The public sector character of the oil marketing companies might have prevented them from hedging their oil purchases.

Two: Gold imports have surged partly due to low prices and partly due to pent up demand. The new gold monetisation, still at the draft stage, has certain welcome features. Even small quantities of gold can be accepted as deposits. Banks can pay the interest in gold. However, in common with the schemes it replaces, the new scheme has one major weakness. It is highly unlikely that individual households will surrender their ornaments for investing in a gold deposit. Normally households do not stock gold bars. Jewellery has a sentimental value that cannot be made good by a deposit scheme, however well designed. It is conceded, however, that the new scheme has to be given a fair trial for the sake of luring investors away from the lure of holding physical gold.

Three: Despite the success of coal auctions, India will remain a net importer of coal well into the foreseeable future.

Four: Exports have fallen on a year on year basis — contracting in April by 14 per cent to 22 billion dollars. A sharp appreciation in the rupee is one of the causes as also a drop in petroleum prices. (India is a major exporter of refined petroleum products.)

To sum up, one has to take note of the apparent paradox in looking at the BOP.

The CAD was at 1.7 per cent in 2013-14 and 1.9 percent during the first half of 2014-15.Those are by no means small feat considering the runaway deficits of the earlier years. Yet there is no scope for complacency. Factors influencing the CAD are beyond the control of the government. It is this, rather than any deterioration, that puts policy makers on guard.

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Printable version | Jul 31, 2021 9:00:05 PM |

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