A glass half full

Need for a holistic approach to external stability

The balance of payments numbers for the first quarter (April-June) of the current fiscal year were published on Monday by the Reserve Bank of India (RBI). Unlike in the previous quarter, there was no attempt to surprise the markets with an unscheduled early announcement of good news; the release was on the scheduled date and, as is now the practice, after market closing. One could infer from this that the news wasn't so good and, indeed, this was the case. The current account deficit for the quarter came in at 4.9 per cent of gross domestic product (GDP), significantly higher than the 3.6 per cent that induced the early announcement three months ago. The press release took the trouble to point out that if gold imports were to be ignored, the current account deficit would have been 3.2 per cent of GDP; a much more comforting number, except for the fact that gold imports cannot be ignored.

Be that as it may, looking ahead, there are indications that the current account deficit may be plateauing. While exports declined during the quarter by about 1.5 per cent, trade data for the first couple of months of the second quarter do suggest something of an exports revival. Given the extent of rupee depreciation over the past three months, this is not surprising and is most welcome. The revival can be reasonably expected to persist as exporters in various sectors compete aggressively to gain market share, even as the US recovery provides further momentum to their businesses. Similarly, while imports grew by almost five per cent during the first quarter, higher rupee prices should lead to efforts to find domestic substitutes. So far, so good. What needs to be kept in focus, though, is that the pressures on the current account deficit from high coal imports and low iron ore exports persist and, as long as they are there, will offset some of the benefits from a revival in exchange rate-sensitive exports. The government simply cannot afford to take its eyes off these commodities.

That apart, the potential reversal in a rather worrying trend is certainly cause for comfort. But, alongside, on the capital account front, another source of vulnerability is brewing. Over the past couple of years, when the current account deficit exploded, the government tried to finance it by increasing debt inflows. Consequently, as the numbers on India's external debt position, which were also published on Monday, reveal, there has been a steady increase in the significance of short-term debt, which has a residual maturity of less than a year. As a proportion of foreign exchange reserves, which is a good measure of vulnerability, it had come close to 60 per cent in March 2013 and crossed that number in June. A significant contribution to this is in the form of non-resident Indian (NRI) deposits, which, some would argue, are relatively committed. But there is little question that a build-up of short-term debt is at least partially offsetting the benefits that a lower current account deficit will bring in the form of greater confidence and a more stable currency. In view of this, restoring external stability needs to be regarded holistically as a process that works to both narrow the current account deficit and steer capital inflows away from short-term debt.