External shocks and the fear factors

Written by Raj Kumar Ray | Updated: Sep 4 2013, 14:41pm hrs
The rupees fall against the dollar by almost a fifth since end-May has triggered widespread debate on what all went wrong for India in the last two years. The rout of the rupee due to fears of Feds tapering of quantitative easing is one of the reasons. But India is not unique to the QE impact. The rupee is affected the most because the country has become more vulnerable to external shocks. Right from macro numbers of GDP growth to current account deficit, to intricate parameters such as reserve cover for imports to debt service ratio, the vulnerability has increased significantly. This fear psychosis is feeding into negative sentiments against the country.

Consider the broader economic scenario, the GDP growth has slid from 9.3% in FY11 to 5% in FY13 and is forecast by some brokerages to slip below 4.5% this year. Although the targets is to rein in CAD at $70 billion (3.7% of GDP) in FY14, it will be more due to subdued non-oil imports than recovery in exports. The problem is how to finance the CAD given the FII outflows.

The other problem is that debt-to-GDP ratio has climbed to 21.2% in FY13 from 17.5% in just two years with a sharp rise in the ratio of short-term debt to FX reserves from 42.3% to 59% between FY11 and FY13. Whats scary is the extent of depletion of FX reservesfrom $309.72 billion in pre-crisis year of FY08 to $277.72 billion in August. As a result, the number of months that our FX reserves could cover imports has come down to 7 from 9.5 in FY11. To mitigate external vulnerability, the government has to do a lot more spade work in coming days. Trying to curb imports by duty hikes alone cant help.