to a widening CAD (4.80% of GDP in FY13) and external sector crisis.
*Dollarisation of economy: The external sector i.e. import & export, was at 15% of GDP in 1990s when the economy was rather closed. With the opening up of economy and globalisation, the external sector has expanded to around 40% of GDP in FY13. This shows that there has been a rapid increase in the import content of the average consumption basket in the last 20 years. The rise in economic growth led to a greater rise in imports than in exports as the investments in the economy could not match the rising consumption rate, leading to a trade deficit reaching 10% of GDP in FY13. Further, the increase of the import content even in the export-oriented industries reduces the effectiveness of currency depreciation as a tool in correcting the external imbalance without an improvement in productivity.
*Oil: Oil is a politically sensitive commodity in India given the implication it has on inflation and the daily budgets of households. Hence the depreciation in currency strains the government fiscal balance since the burden is not passed onto end-consumers. Any rise in fiscal deficit without an increase in the productive capacity of the economy indirectly fuels inflation and reduces the effectiveness of monetary policy in maintaining the growth–inflation balance, primarily by the use of interest rates.
*Gold: As much as it is a tradition to buy gold in India, the investment in gold is a savvy economic decision by the Indian households as it is the only asset that strengthens the household balance-sheet in case of a depreciating currency and an inflationary environment. This, however, puts pressure on the financial savings in the economy and hold up investments (savings-investment-current account theory) as Investment is the sum of domestic savings and external savings (current account balance). The lack of investment to fund the infrastructure aggravates this inflation/inefficiency, leading to currency depreciation. Thus, the vicious cycle continues.
*Twin deficits: The deficits should be run only if they can pay for themselves in the future, else they reach unsustainable levels and stalls the development process and exert