With indirect taxes continuing to fall below target thanks to a slowing economy, the fiscal deficit has already crossed 80% of the years budget target in the first 8 months and suggests the full years deficit could likely surpass the new target of 5.3% of GDP. This is despite the finance ministers tight expenditure control. What is far more worrying, however, is the sharp deterioration in the current account deficit to 5.4% of GDP, from an improved 3.9% in Q1. Which explains why, despite the healthy FII and FDIFDI was around $5 billion higher qoq and FII $9.5 billionthe rupee continues to remain under pressure and closed Monday at 54.9950 to a dollar.
Given that exports have contracted in 7 of the 8 months since April, most expected the current account deficit to rise, but the extent caught most observers unawares. Traditionally exports of services, software services especially, have taken the slack from merchandise exports, but these have been under pressure over the past year. Software exports were just $15.6 billion in Q2, a hike of just 3.7% qoq as compared to a hike of 14.1% yoyin other words, the global slowdown is really biting, and things could get worse with growth slowing even more in Europe and the US likely to slow whether or not a final solution is found to the fiscal cliff. What comes as a bit of a surprise is whats happened to private transfers which fell from $16.8 billion in Q1 to $16.1 billion in Q2; NRI deposits, similarly, have fallen by close to $4 billion qoq though they are at the same level they were a year ago. Which means the kick to the rupee that was got through higher FDI levels has largely been neutralised by lower NRI inflows. Though there has been a hike in gold imports by a little over $1 billion on a qoq basison a yoy basis, gold imports have fallen $2.5 billionthis cant explain the sharp deterioration in the CAD by around $5 billion on a qoq basis.
Whats worrying is that based on trade data available so far, it looks like the CAD in Q3 could be along similar lines. As compared to a balance of trade deficit of $49.3 billion in Q2 based on the monthly data that is put out, the deficit was $40.2 billion in just the two months of October and November; services exports are also expected to be under more pressure in December. Given how, as RBI pointed out in the Financial Stability Report on Friday, the ratio of volatile capital has gone up in Indias total forex reservesthis was up to 81.3% at the end of June as compared to 79.9% at the end of Marchthis means the government needs to calibrate its policy response very carefully. Even the slightest sign that the government is going slow on economic reformswith the introduction of an ambitious food security bill, for instancecould end up spelling trouble for the rupee.