Indias current account deficit (CAD) in the July-September quarter turned out to be far worse than anticipated, a record 5.4% of GDP. Even during the quarters following the sharp depreciation of the rupee since August 2011, the deficit had remained between 3.9% and 4.5% of GDP. (The quarters post the financial crisis of 2008 are not valid comparators since the prices of commodities, particularly crude, had come down sharply.)
Which parts of the accounts were the major culprits Stepping back, a bit facetiously, note that some part of the worsening was due to the rupee depreciation. Valuing the balances at the average rupee level of the corresponding second quarter of a year ago (R45.8 to a dollar), rather than the actual average (R55.1 to a dollar), the deficit would have been 4.5% of GDP, although this would have remained disconcertingly high. Facetious and not very convincing, since the rupees depreciation is actually an endogenous signal of the deterioration of the CAD.
But this is not the way the current and capital account flows are supposed to work. Theoretically, the weaker rupee should have been an incentive to switch from imports to domestic substitutes and for exports to have increased by becoming more competitive (see chart for co-movements). Why are many of the underlying assumptions of this hypothesis turning out to be flawed While the currency changes have indeed had an effect, the effects have been varied and inconsistent, and need deeper insights into the mechanisms, which have actually driven the flows. The following paragraphs are a start in this direction.
For starters, the deterioration in the CAD in the second quarter came in almost entirely from lower merchandise exports, while imports have remained just below the first quarters level (see table for a summary view of important balance of payments components).
Exports have refused to increase. This is not to worry about the terrible growth rates (an average of minus 5.7% yoy over April-November 2012, and minus 6.7% over April-September 2012), since the growth rates had been 34.7% and 41.8% in the corresponding months in 2011 (we think we know the reasons being a rush to try and beat incentive deadlines of September and, we are told, a tendency to over-invoice). What is worrying is a drop in the value of exports (from $201 billion in the first eight months of 2011 to $189 billion, give or take a couple billions due to the uncertainty about the quality of data capture). Exports are also getting more concentrated; a large chunk of even this lower export level came from increased exports of guar gum meal (the stuff used now for shale gas extraction).
This is all the more worrying since there is some evidence that global imports have improved, however weakly. The picture is not pretty, though. The Baltic Dry Freight Index (BDI), a benchmark for freight prices, has remained at more or less the same levels. However, the Global Trade Monitor published by CPB, Netherlands, shows that, till October, imports from emerging markets have improved sharply since August. Most of this increase came from imports into Africa and the Middle East. Is India missing out on this geography
What about on the import side Everyone now knows (or assumes) the proximate reasons for the inelastic imports: crude and petroleum products, and gold, but only part of this is correct. Weakly congruent with theory, non-oil imports have indeed fallen ($209 billion this fiscal year, compared to $215 billion in the corresponding period last year). But thats despite a fall in gold imports by almost $10 billion in the April-September reference period (and even further into October), compared to the same months last year. Net imports of gold in the two quarters had dropped from $25 billion in 2011 to $9 billion this year. This has presumably happened due to a compression of internal demand, since the drop in gems and jewellery exports has been much smaller, although much of these lower imports were in the first quarter.
Oil imports, therefore, have been the prime mover of sticky imports, increasing from $99 billion in the first eight months of 2011 to $110 billion. Note that this increase was also over months when the average price of the Indian crude basket was around $109/barrel (compared to $112/barrel in 2011). Even this data is troubling; these commerce ministry numbers are almost $10 billion higher than the more detailed breakup given by the petroleum ministry, which shows that crude and petroleum product imports have been about the same in the reference months of the two years. We will delve into more details on Indias petroleum trade in a companion column.
Bottom line of this limited scan Bringing the CAD down to more manageable levels will probably have to happen through managing imports, where we might have more levers. Export growth will probably have more to do with infrastructure and logistics bottlenecks rather than currency, although tax and interest rate incentives might have some shallow effects.
The author is senior vice-president, business & economic research, Axis Bank. Views are personal