The trade deficit for India has expanded to just a shade short of $10 billion in just one month of fiscal 2008-09. That is a fairly somber note to open the year. If the trend persists, India could end this year with a trade deficit of over $100 billion, netting out a couple of months of plus and minus. In absolute terms that means blocking up a third of the total foreign exchange reserves for meeting this deficit. For comparison, fiscal 2007-08 ended with a merchandise deficit of $80 billion.
What does this do to the level of current account deficit? Would it therefore touch something like 3.5% of the GDP? Fiscal 2007-08 had ended with the deficit on a far happier note at close to 1%. The trinity that now scares analysts is the combination of a high deficit propelled by fuel imports, way above the $77 billion recorded last year as prices climb up, the expanding trade gap despite a fall in rupee and a shrinking capital flow from abroad. In that combination, the foreign exchange reserves would be thin platform to weigh on.
But this is not necessarily correct. Indeed, this is going to be a year of turbulent financial markets across the world. That would mean the options of financing the deficit are going to be clipped. But so far, there is little evidence of any trend that global finance is swishing out of emerging markets, fearing a collapse. Sure, year to date the foreign institutional investors have withdrawn net $5 billion from the Indian stock markets, compared with the accretion of $19.5 billion in 2007. The key factor is that this reversal has nothing much to do with the weakness of the Indian stock markets.
Till June 17, 2008, as per Sebi data, the FIIs have made a gross investment of $9.9 billion (year to date). In the same period last year that investment was far less at $6.8 billion. This basically means there is no lack of interest among overseas entities to bet on India. There is reason for that. Going by the lowest estimate, the one put out by the Global Development Finance report of the World Bank, the Indian GDP growth is expected to be 7%, one of the two best growth rates in the world. In fact, that is the key theme of the current turmoil in the financial markets. The emerging markets have not turned out to be a problem the way they did in 1997. It is the crisis in US markets, allied with the threat of recession, that has moved funds. This difference is important. It is, therefore, hard to imagine a fund manager keeping India out of his options for investment in any significant way, once conditions in the US markets stabilise.
There is also another aspect to the FII flows. The first half of any year is typically a time for low funds inflow. They peak in the second half, so a more sanguine view of the figures would emerge only after September. Hitherto dominant in the FII flows has been the US-based endowment and pension funds. These have been hurt in the credit derivatives crisis. To a large extent, that role could be taken by sovereign wealth funds. Petrodollars from West Asia are beginning to find the Indian markets more accessible than elsewhere. Of the 1,392 FIIs registered with Sebi, in June 2008, the newer ones have large exposure in that region. Government officials are convinced that they have been able to persuade a number of these funds to try the Indian growth story. This is one aspect of global finance that is just emerging, and it is quite likely that 2008 could be the first year where they play a significant part. According to World Bank estimates the global corpus of the wealth funds could be in the region of $3.2 billion. It is not surprising that RBI and Sebi have moved to ease entry conditions for venture capital and for the first time listed sovereign wealth funds as a permissible entity in the stock market. Yet more than the stock markets many of the funds are keen to tap the foreign direct investment route. This too had peaked in 2007-08 to $29.9 billion. While, year on year there is no agency that could take a call on whether the flow would be topped up in this fiscal, it is hard to imagine a scenario where it slips back appreciably from there. The FDI flow into India has moved up fairly gradually in tandem with the growth rate of the economy and despite the hiccups generated by the political compulsions, no reversal of the openness of the economy has occurred. Giving a leg-up to retail FDI at this juncture could have proved timely.
The current account deficit is a robust tool to draw upon savings in the rest of the world to the economy. In 2001-03 when the account was in surplus, it naturally coincided with sluggish investment and growth in the economy. The chaos in the global market, but with India riding it out, is a good chance to use the deficit to open up to global finance.
subhomoy.bhattacharjee@expressindia.com