Originally Published 2013-01-10 00:00:00 Published on Jan 10, 2013
The main culprit for the sharp rise in the current account deficit is the increase in gold imports and the hefty payment for oil imports. People are buying gold because they are apprehensive about the outlook on inflation. They think of gold as a reliable asset whose value has appreciated the most in the past few years.
Economy at a critical juncture
The year 2013 has begun not so well due to various reasons. First, of course, is the death of a girl in her prime due to gang-rape. On the more mundane economic front, there is the alarming news of a big jump in the current account deficit (CAD) which denotes all transactions of currently produced exports of goods and services plus all invisibles like payments for insurance, shipping, tourism, and cash transfers like remittances, interests, profits and dividends, minus all imports and other similar outgoing payments. The CAD reached 5.4 per cent of the GDP in the second quarter of 2012-13 (July to September) when the sustainable level is supposed to be around 2.5 per cent. The high CAD ( $22.3 billion) is putting pressure on the rupee which has already depreciated by 6.8 per cent in the past 12 months.

While the rupee’s depreciation has led to a slight improvement in the exports of some items, it has also led to pressure on companies’ pricing of their products because of higher raw material costs, making them uncompetitive. There has been a marked slowdown in exports which declined by 12.2 per cent during the second quarter as against a rise of 45.3 per cent during the corresponding quarter of 2011-12. This slowdown has contributed to the widening of the CAD and is due to the fact that goods and services to western markets are facing a declining demand.

The main culprit of the sharp rise in the CAD, however, is the increase in gold imports and the hefty payment for oil imports. India has to import 75 per cent of its oil requirements and though the oil prices have not gone up hugely, the imports have not declined either. The oil price has hovered around $85 a barrel. As Dr C. Rangarajan, chairperson of the PM’s Economic Advisory Council, said recently "if you exclude oil and gold, imports are not very disturbing", which means that these two items are mainly responsible for the rise in the CAD.

People are buying gold because they are apprehensive about the outlook on inflation. They think of gold as a reliable asset whose value has appreciated the most in the past few years. Private commercial banks are also endorsing this idea. There is much hype in the advertisements imploring customers to buy gold during festivals as if it is the most endurable and safe investment. No wonder, there has been a rise in the demand for gold. Now the government is considering a tax on gold imports and hopefully it will help in curbing the demand.

On the inflow of dollars into the country, which is critical for managing the CAD, there has been a steady though slow increase in remittances and software export earnings. The government, however, thinks it will be able to manage to bring down the CAD in the third quarter because so far foreign institutional investment (FII) inflows have been good and there has been an increase in external commercial borrowings (ECB) from abroad by the corporate sector. There has also been an increase in foreign direct investment inflows. But there could be problems ahead.

First, the FDI inflows may not gather momentum despite the opening up of multi-brand retail sector to 51 per cent of foreign equity because foreign investors may perceive quite a few impediments in the available infrastructure in India. The biggest prospective foreign investor, Walmart, is undergoing investigation by the US government for bribery charges in India. This may take time to resolve and during this controversy, it may want to wait for some time till the ground is cleared.

Another trend is that there has been an increase in NRI deposits due to various incentives offered by the government and thus funds have been made available for corporate borrowing. Too much short-term borrowings by the corporate sector can lead to an accumulation of short-term debts which can prove dangerous. A sudden withdrawal of funds by lenders can land the country in a crisis as well as bunching of credit payback may create problems. The government is, however, not terribly worried and may be considering widening the scope of the External Commercial Borrowings (which has gathered much popularity) further to make up for the shortage of dollars and the prevailing high interest rates in the markets. The government has given an incentive to the corporate sector for the ECB by withholding tax on such borrowings.

India’s external debt has been rising, and though it is not in a danger zone yet, it was $365.20 billion by the end of September 2012, which meant an increase of $20 billion from the previous year. It will put pressure on the economy’s foreign exchange reserve position. All this may make India a little less attractive as an investment destination.

Regarding the FIIs, which have been coming in droves again to India in 2012 (FIIs topped $20.2 billion in the first 11 months of 2012) as a result of a rise in global liquidity due to quantitative easing by the central banks in the US and the EU, there has to be some caution because FIIs are fickle in nature. To depend on them for financing the dollar needs of the market is playing with danger. They come in when the prospects of a country’s stock market seem rosy and withdraw at the slightest hint of a downturn. All this makes the position of the stock markets quite tenuous and vulnerable, and will put pressure on the rupee and may lead to its further depreciation which will fuel inflation.

Another ominous development is the fiscal deficit, which is not showing any signs of compression in meeting the proposed deficit target of 5.1 per cent. The deficit of government spending over revenue collection has already reached 80 per cent of the budgeted levels. If budget deficit exceeds 5.8 per cent of the GDP, there will be further inflationary pressure generated by the government’s borrowing programme which will involve the release of more money in circulation.

Thus, both a high CAD and a high fiscal deficit will lead to higher inflation which will make people turn more to gold as an asset, not bothering about a rise in its price. There will be much pressure on the government for reducing food and fuel subsidies, specially diesel subsidy, otherwise various important infrastructure programmes would get affected and curtailed.

For the government to make a turn-around this year would be essential and the first task would be to see that inflation is reined.

(The writer is a Senior Fellow at Observer Research Foundation)

Courtesy: The Tribune,
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David Rusnok

David Rusnok

David Rusnok Researcher Strengthening National Climate Policy Implementation (SNAPFI) project DIW Germany

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