During his Budget presentation and in many TV appearances thereafter, finance minister P Chidambaram voiced his worries about the state of Indias current account deficit (CAD). His fears seem to have surfaced with data released on March 28 by RBI showing that the CAD has widened to a record high 6.7% of GDP in the December quarter. According to RBI, the CAD increased from 5.4% in Q2 (July-September) to an unprecedented high of 6.7% of GDP in Q3, driven mainly on the back of a large trade deficit due to heavy oil and gold imports on the one hand and subdued exports on the other. These developments are likely to keep the rupee under pressure but only as long as the imbalance persists. Moves are now afoot to address the vexing issue of promoting exports as a way to address the trade deficit on a more sustainable basis.
In Q3 (October-December), the CAD was $32.63 billion compared with $22.3 billion in the September quarter and $20.16 billion in the corresponding quarter in 2011. For the first nine months of this fiscal (April-December), the CAD stood at $71.7 billion, representing 5.4% of GDP compared with $56.5 billion (4.1% of GDP) in the same period of 2011. The CAD has deteriorated and will almost certainly be worse in the current fiscal compared with the 4.2% achieved last year (see table 1). Recent monthly data on trade, however, provides some late relief, suggesting that the gap for Q4 will be lower than the levels of the last two quarters, thereby helping to somewhat contain the CAD for FY13.
Exports rebounded 4.2% in February to $26.3 billion for the second consecutive month, although they have declined in 9 of the past 12 months, due in part to Europes debt crisis, but also due to the many domestic structural impediments that have begun to hurt. Import growth on the other hand was relatively smaller at 2.6% in February, clocking $41.2 billion (see table 2). As a result, the trade deficit narrowed to $15 billion in February after averaging about $20 billion a month in the previous 4 months. The recent slowdown in imports was primarily due to contraction in non-oil imports by 3.6%. On the whole, however, exports were down 4% in the 11 months up to February compared with the previous year, while imports at $448 billion were marginally up 0.2%, resulting in the deficit widening to $182 billion compared to $170 billion for the corresponding period last year. For FY13, the trade deficit is likely to be around $200 billion. The government plans to provide incentives to exporters in its annual trade policy due in April as part of its efforts to tackle the trade gap.
Invisible trade, including remittances, has been the mainstay of Indias foreign exchange earnings, routinely helping restrain the CAD, which would have been perilous otherwise. Net invisibles exceeded $110 billion (more than half of which were remittances) last fiscal, and are likely to be of the same order of magnitude in FY13, resulting in a CAD of about $90 billion or around 5% of GDP. Given the elevated levels of the CAD (recall that CAD was over 3% of GDP in 1991 and 4.2% of GDP last year), there are legitimate concerns over its financing. Unfortunately, there are no easy solutions especially in the backdrop of slippage in global demand for our products and the inelasticity of our own import demand, especially gold and oil.
Inbound investments into equity and debt have so far enabled India to finance the CAD but some of these flows are susceptible to sharp reversals, exposing existential BoP risks. Thus, the government is reviewing FDI policy in several sectors, including insurance, civil aviation and retail, since financing the current account using FDI inflows is less risky. Importantly, there is an urgent need to address structural issues that will boost our export competitiveness.
Following the BoP crisis in 1991 when the CAD crossed 3% of GDP, reforms and structural adjustments led to a turnaround in the external sector, with India recording current account surpluses for three years between 2001 and 2004. While no one would seriously argue for India running such a surplus at this stage, our current account imbalance has turned grim despite the surplus in invisibles, reflecting a progressively worsening merchandise trade deficit. Despite sizeable foreign exchange reserves, the import coverage has steadily come down from 14 months in 2008 to 6.3 today (see table 1).
The situation warrants immediate attention but unfortunately there is no quick fix. Increasing competitiveness is a vexing issue, since the only sustainable way to help goods exports is to resolve infrastructure and labour market constraints. The recent Economic Survey identified this as well when it stated that about 80% of all stalled projects belonged to 6 sectors: electricity, roads, telecommunication services, steel, real estate and mining. One possibility could be to give tax and other incentives under SEZs to further exports. In this years Budget too there was an enhanced tax deduction (depreciation for large investments) so there is a precedent for being selective. We also know that governments in the high-growth East Asian economies were not free-market purists. They used a variety of policies to help diversify exports or sustain competitiveness but these policies are highly controversial. Subsides, we know, are awfully difficult to reverse and therefore the government should be clear about what it wants to achieve on the export front. Ultimately, it has to find enough cash to spend on infrastructure, something that is critical to increasing exports and indeed long-term growth.
The author is director and chief executive, ICRIER