Worrying numbers compound problems

At the beginning of the New Year, there has been a succession of bad news concerning the external sector. The Reserve Bank of India (RBI) released its quarterly report on balance of payments (BoP) covering the period July-September 2012, the second quarter of the current fiscal year. The report showed the current account deficit (CAD) spinning out of control to reach a record 5.4 per cent of gross domestic product (GDP). This is sharply higher than the 4.2 per cent recorded during the same period last year. In absolute terms, the CAD worsened to $22.3 billion in the second quarter from $16.4 billion in the preceding quarter (April-June 2012) and $18.9 billion a year ago.

External debt

On the same day, the finance ministry released a report on India’s external debt as on September-end. India’s external debt stood at $365.3 billion, up by $20 billion over the level of March 2012. These figures by themselves do not mean anything but the finance ministry’s explanation for the jump is telling. According to the report, the rise in external debt is largely due to higher non-resident Indian (NRI) deposits, short-term debt and commercial borrowings. Long-term debt, at $280.8 billion at end-March, was up by 5.1 per cent over end-March. Short-term debt, accounting for 23 per cent of the total external debt, increased by 8.1 per cent to $84.5 billion.

Limitations of policy-makers

The two data releases are significant in that they show the limitations of policy-makers in arresting the deterioration in two key external account indicators.

Take the current account deficit first. The expectation among policy-makers has been that it could be contained within “reasonable” limits of between 3.5 per cent and 4 per cent of GDP by March 31, 2013. That now looks very difficult to achieve, if not impossible.

Merchandise trade deficit, the excess of imports over exports, widened to $48.3 billion during the second quarter of the current fiscal year, up from $44.5 billion a year ago. Exports recorded a decline of 12.2 per cent and imports by 4.8 per cent. During the corresponding period last year, exports and imports had increased, making this year’s decline all the more pronounced.

Exports have declined month after month this year, the reason being that the principal markets for India’s exports, the developed countries, have not yet recovered from the recession. There is not much that the Government of India can do to reverse the decline beyond export promotion measures targeted at specific sectors. Recent foreign trade policies have sought to diversify foreign trade away from traditional markets and products. This is a strategy worth pursuing even if it is going to pay dividends only in the long haul.

Imports have decreased but not at the level of decline in exports. The two significant contributories to imports are petroleum and gold. During 2011-12, gold imports were of the order of $56 billion. The Finance Minister has hinted at raising the tariff on imported gold in the Union Budget. The difficulty with tariff barriers and physical controls is that either the higher cost might be absorbed given the inelastic demand, or the trade might be driven underground. The government will, however, have to persist with a wide range of measures to lower the demand, and, hence, imports of physical gold. Attempts at developing and popularising gold-linked deposit schemes, through mutual funds and banks, ought to be encouraged.

Portfolio flows

For the overall balance of payments, the implications of the trade and current account deficits are clear. The dependence on portfolio and other capital flows through foreign institutional investors (FII) continues. Recent months have seen a bounty of such flows into the stock markets, boosting their valuation. Exactly a year ago, the situation was very different as the FII pulled out and the indices tumbled.

Adding to the problem, certain other categories that would help in reducing the trade deficit have been coming in at a slower pace. For instance, net receipts under private transfers and other earnings from “invisibles” such as software exports have grown at a more modest pace than a year ago.

There are reasons to worry over India’s external debt, too, though for very different reasons. Whereas factors behind the CAD are mostly beyond the control of the government, it is wrong policies that have accentuated the problems connected with external debt. As the finance ministry has pointed out, the rise in external debt is largely due to higher NRI deposits, short-term debt and commercial borrowings. Recent government policies have sought to encourage these, driven by reasons of expediency. For instance, the government has sought to tap the global markets awash with liquidity through external commercial borrowings. NRIs have been given special concessions.

These policies represent a U-turn. Not long ago, the government sought to discourage the flow of funds from these sources. The rates on NRI deposits were pegged lower, and by prescribing stiff caps on borrowings through ECBs, the government ensured fewer borrowings. The accumulation of short-term loans might pose a threat to external account stability, if “bunched up “repayments” become due.


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