Column: India?s CAD paradox

How much does ?excess aggregate demand? explain the worsening?

We had written about India?s large and troubling current account deficit (CAD) in early January and how the theories of currencies and finance seem to be failing in India. One would have thought a priori that the massive depreciation of the rupee would have set in motion ?automatic stabilisers? to narrow the deficit, through making exports more competitive and imports costlier. Since then, things have only got worse, although the rupee has stabilised at relatively weak levels. On the face of it, India?s CAD will probably end up being more than 5% of GDP this year, much worse than last year?s 4.2% (although there is an ambiguous element in this statistic, as we will see later).

A description of CAD?s deterioration first. CAD in the first six months of FY13 was $2.5 billion higher than the corresponding period of FY12 (no big deal of itself), caused by a $1.1 billion increase in the merchandise trade deficit and a $1.4 billion drop in the invisibles surplus (rounding shows up as small discrepancies). The trade deficit increase, even as imports fell $10.4 billion, was caused by a $11.7 billion drop in exports. The drop in the invisibles surplus was due to a small $800 million drop in net services exports, while an increase in private remittances more or less balanced out an increase in payments of interest and royalties (see table 1). The most alarming aspect of the CAD deterioration, then, was a drop in merchandise exports.

Zeroing in on the trade component, the trade deficit (based on commerce ministry data, slightly different from RBI data) increased by $3.7 billion in the April-September FY13 quarter (compared to the first six months of FY12), due to $12 billion lower exports and $9 billion lower imports. Of the $9 billion higher imports, petroleum imports increased by $5 billion while gold (and silver and precious stones) imports fell by $17 billion, leading to the two combined resulting in a drop of $12 billion. Therefore, imports of other commodities would have increased by $3 billion. Various items have offset each other, more or less, but $2.2 billion is listed as ?returned goods?, and another $0.5 billion as edible oil imports. The evidence for domestic aggregate demand as the cause of CAD worsening is not very strong.

Would CAD likely have deteriorated in Q3? Although difficult to be definitive for want of data on remittances and interest payments, the merchandise and services data suggests that it did, although the source of the worsening was more to do (net) oil and gold imports. In the October-December 2012 quarter, the merchandise trade deficit increased $12.3 billion, led by a $2.3 billion drop in exports and a $10 billion increase in imports (table 2). The increase in imports, inter alia, was caused by $7.4 billion higher (net) petroleum imports and $3.7 billion (net) higher gold imports. Shorn of (net) gold and oil, the contribution of other commodities to the worsening trade deficit was minimal. Sure, there were changes in the composition of the other commodities, the net effect of the combined changes was minimal.

The bottom line is that the deterioration of the current account seems predominantly to be the effect of a combination of gold and oil, which are probably?at least, directly?not reflective of excess aggregate demand. This is not a puzzle, given that demand elasticities of petroleum consumption had remained suppressed due to subsidised prices, and with gold consumption driven by different dynamics. Also, the situation in the third quarter was an improvement over the first half, although there is little to indicate that this improvement will sustain. The January 2013 trade data points to a deterioration, although initial reports suggest that this was due to a (one-off?) surge in gold imports.

The story doesn?t end here. The discrepancies between the merchandise trade data released by RBI and the ministry of commerce (DGCIS) are known and reconcilable. But this is not the case with data on petroleum imports and exports released by DGCIS and separately by the petroleum ministry (PPAC). Table 3 shows the massive increase in magnitude of the deviation (for the first nine months of FY13) between the two numbers, with the PPAC data showing a $11 billion lower petroleum imports, compared to the commerce ministry. About $5 billion of this was in the October-December quarter alone, a third of the total increase in petroleum imports in April-December 2012 (relative to corresponding nine months of the previous year).

There?s yet another angle?a valuation angle?to CAD, measured in proportion to GDP. The latter needs to be converted into dollar terms using the doller-rupee exchange rate. One of the fears expressed about CAD was the sharp rise in the CAD/GDP ratio from 2.6% in FY11 to 4.2% in FY12, 4.6% in April-September FY13, and now projected to be even higher (maybe close to 5%) in FY13. While not in the slightest downplaying the degree of concern, we do need to point out that some of this is due to the weaker rupee. If we convert the H1 FY13 GDP to dollars using the H1 FY12 dollar-rupee (45.3, instead of 54.6 in H1 FY13), the CAD/GDP ratio drops to 3.9%, down from the reported 4.6%. This is not entire notional jugglery. Although it can be argued that the weaker rupee was, in itself, the result of external and internal weaknesses, the recalibration might be the result of lower capital flows (we have seen the CAD had not deteriorated significantly in dollar terms).

None of the above is meant to downplay the gravity of India?s high CAD. However, targeted correction measures are urgently needed, which the fuel price rationalisation is beginning to address. High inflation is one of the reasons for the surge in gold demand, which has been the focus of monetary policy. Hopefully, these measures will ameliorate one of India?s key macroeconomic imbalances.

The author is senior vice-president, business & economic research, Axis Bank. Views are personal

Column: India?s CAD paradox

We had written about India?s large and troubling current account deficit in early January and how the theories of currencies and finance seem to be failing in India.