-Richa Gupta & Umang Aggarwal
The impact of changing global dynamics, especially monetary policy normalisation and stronger dollar movement, has become visible across the Asian landscape. A key impact has been the downward currency movement, where the rupee has moved in tandem with its Asian peers. However, the rupee has seen the largest decline and currency movements are believed to remain under stress in the period ahead. This, coupled with upward pressure from oil prices, is expected to keep the imports bill high, given that oil imports make up for about 36% of total imports. With exports still benign, India is looking at an inflated current account deficit (CAD), which is expected to breach the 2.5%-mark in FY19.
In FY18, CAD was 1.9%, and is currently at 2.4% of GDP (Q1-FY19), largely driven by a widening trade deficit. Oil imports alone have led to a total outflow of over $108 billion in FY18, compared to $87 billion in the previous year, and with the expectations of crude oil remaining at elevated levels, coupled with currency devaluation which has already reached about 72 per dollar level, the imports bill can only be expected to rise. A major component to finance increase in imports bill is foreign reserves and capital inflows; however, this situation has seemingly come under some pressure too. Foreign reserve levels have declined from $420 billion in April 2018 to $400 billion at the end of August 2018. Some of this decline may have occurred due to the central bank’s intervention in currency markets.
Within CAD, trade deficit accounts for the largest variation and, historically, India has always had a current account deficit largely arising from high merchandise imports, and imports bill on oil and gold. This is because as Indian economy grew, so did its demand for imports. Imports have moved from largely comprising of raw materials to a basket more tilted towards electronics and such value products, whereas exports have not seen a similar increase in high value-add sectors. In the medium term, improving the value of composition of exports through reforms and trade incentives is important if India has to regain the trade advantage from its peers. Previously, Indian governments managed to control CAD largely through investment inflows generating capital account surplus—when it had reached 4.8% levels in 2012-13 and was gradually brought down to within the 2% limit between 2013-14 and 2017-18. This period saw higher services exports, healthy remittances and net capital inflows, while softened oil prices between 2015 and 2017 also helped lessen the deficit.
CAD is again on an upswing, and at a faster rate. The increase in non-oil, non-gold imports is a positive for stronger domestic demand. But slowing investment outflows are likely to make financing of the deficit difficult. The pace of increase in FDI has softened from $43.5 billion in FY17 to $44.9 billion in FY18, while foreign portfolio investors (FPI) have pulled out close to $8 billion from the securities market since April 2018. Some of the steps that can be taken to increase the flow of investments include speeding up project implementation, further liberalisation of FDI norms, enabling ease of doing business, and providing more support to MSMEs, etc.
At present, CAD remains within the 3% safe zone; however, any further rise and monetary and fiscal pressure may build, with limited scope of manoeuvrability. In this context, managing both the foreign reserves as well as stimulating exports has become imperative.
The government has announced a five-step formula to address rising CAD levels. It has announced restrictions on 19 “non-essential” imports such as gemstones, jet fuel, plastics, home appliances and shoes. In order to encourage capital flows, it has also taken measures like elimination of withholding tax on masala bonds (rupee-denominated debt sold overseas by corporates), relaxation on FPIs by removing exposure limit of 20% of FPIs’ corporate bond portfolio to a single corporate group and 50% of any issue of corporate bonds, and enabling manufacturing units to access external commercial borrowings (ECB) up to $50 million for a minimum maturity of one year. The impact of these measures will be seen in due course.
Recognising that the current scope of CAD is largely an external phenomenon, there is a need to focus on export promotion and increase factor productivity for better terms of trade. Good economics would also suggest that the government continues to maintain a conservative stance on fiscal consolidation, as maintaining the hard-won macroeconomic stability is important for the Indian economy to be able to source the capital required for its development needs.
-Gupta is Senior Economist and Senior Director, and Aggarwal is Economist, Deloitte India