Managing current account

Budget could have done more about external vulnerability

The Union Budget that was presented last week has made a major effort to resuscitate India's economy and shown greater fiscal discipline by cutting government expenditure in the current year and promising a lower fiscal deficit in 2013-14. Nevertheless, the Budget can and will be judged on various fronts what it provides to the private sector; its effect on jobs, the social sector and the environment; and how much it cuts government waste. And in some ways an important prism through which it should be viewed is what the Budget will mean for India's external vulnerability. If India is, as so many fear, vulnerable to a crisis of some sort because of its balance-of-payments weakness, then the Budget should have given greater priority to fixing this problem, and reducing the current account deficit. Unfortunately, viewed from that perspective, the Budget has not done enough.

The outlines of India's difficult current account situation are already well known. A sustained rise in the price of oil has caused the fuel bill to explode, as domestic demand for fuel has been inelastic thanks to the governments sheltering of domestic consumers from world prices. Meanwhile, an increased risk environment, high inflation and unattractive financial assets have caused many investors to flee to gold as a store of value and source of capital gains, meaning that gold imports have increased considerably, too. Thus, the trade deficit increased sharply, as a weak world economy combined with uncompetitive Indian products to decrease Indian exports. The trade deficit was financed with capital inflows; some of that was short-term money. While India still has a comfortable amount of foreign currency reserves, they can buy only about seven months of imports now, much less than what they could a few years ago. Combine this with an increased store of dollar-denominated government debt, and the Indian economy's vulnerability to a crisis becomes obvious.

The only response to such a situation that a government is capable of making is to ensure that the savings-investment gap is reduced, so as to bring down dependence on external financing of the current account deficit. In other words, it needs to reduce public dissaving the gap between revenue expenditure and revenue income, or the revenue deficit. While it is true that the fiscal deficit was the focus of the finance ministers attention, much of the chopping of expenditure happened on the capital account. Even the classification of telecom spectrum receipts as revenue part of the 32.8 per cent increase in non-tax revenue that this Budget has accounted for in 2013-14 has not been sufficient to decrease public dissaving sufficiently. In 2012-13, the revenue deficit was 3.9 per cent of gross domestic product. This Budget proposes to bring it down to 3.3 per cent next year. Even when the doubtful numbers are ignored, that is an effort that the finance minister can point to for the benefit of the world markets as a sign that India is getting its house in order, and as an indication that it will come down further. The question, however, is whether world markets will wait for that process to play out. Those who believe that the markets wont have that patience will wish that the Budget had gone the extra mile for a slightly higher cut in the governments revenue deficit next year.