‘Rising dependence on external capital to fill the gap doesn’t seem sustainable’
The biggest risk to India’s growth story is deterioration in its external balances, with the current account deficit likely to rise to four per cent of gross domestic product (GDP) in the year to March 2011, the Goldman Sachs group said in a report released on Tuesday. The deficit was 2.9 per cent a year earlier.
In the year to March 2012, the current account deficit could rise further, to 4.3 per cent of GDP, India’s highest ever level, it said.
| YAWNING GAP RISING IMPORTS TO WIDEN THE CURRENT ACCOUNT DEFICIT FURTHER | |||
| ($ bn) | 2009-10 | 2010-11F | 2011-12F |
| Total merchandise exports Oil exports | 182 28 | 227 44 | 294 73 |
| Total merchandise imports Oil imports* | 299 85 | 384 117 | 484 158 |
| Service exports | 94 | 120 | 149 |
| Service imports | 60 | 77 | 96 |
| Total exports | 276 | 347 | 443 |
| Total imports | 359 | 460 | 580 |
| Income and transfer | 45 | 46 | 50 |
| Current account balance | -38 | -67 | -86 |
| CA balance ( % of GDP) | -2.9 | -4 | -4.3 |
| Basic BoP (CA + FDI + FII) (% of GDP) | 1.0 |
| |
-2.0
BBL for FY11 & FY 12 respectively
Note: Basic balance of payments = current account deficit + FDI + portfolio inflows.
Source: CEIC, GS Global ECS Research.
India is increasingly financing its deficit by short-term capital, that is, increasing its short-term debt and raising its external vulnerability. Almost 80 per cent of capital flows are not related to foreign direct investment, it said.
‘Dampen the rupee’
India’s policy response should include tighter fiscal and monetary policy and preventing the currency from appreciating. The Reserve Bank of India will have to raise key policy rates by up to 75 basis points by June next year to moderate demand, it said.
Goldman projects the rupee at 44 per dollar and 43 per dollar, respectively, in the next three months and 12 months, respectively, driven mainly on the dollar’s global weakness. The rupee closed at 45.32 to the dollar on Tuesday.
D Subbarao, governor of the Reserve Bank of India, said on November 2 that the current account deficit was a challenge. The full-year deficit looked like rising to 3.5-3.7 per cent of GDP, by extrapolating the first quarter’s number, but RBI expected the deficit at about three per cent, he said.
The challenge was to narrow the current deficit in the medium term and finance it in the short term, he had noted. On being asked, an RBI spokeswoman said the central bank could not comment immediately on the Goldman report.
Outstanding external debt with maturity of less than a year rose to $115 billion, or about 42 per cent of the gross reserves, the report said. The figure includes trade credit and the short-term portion of the deposits of non-resident Indians that are due to mature over the next one year. The deposits are often rolled over in normal times, but during times of risk, any reversal could add to a nation’s vulnerability, it said.
It was India’s strong domestic demand which helped the nation tide over the global economic crisis of 2008. This is now leading to a sharp rise in imports, sluggish exports and pushing up the current account deficit, it said.
Import hunger, sluggish exports
“Given the strong outlook for growth in FY12 (2011-12), the large infrastructure import needs, such as road and power equipment, and India’s increasing reliance on commodity imports of oil and coal, we think import demand may remain robust in FY12,’’ analysts Tushar Poddar and Vishal Vaibhaw said in the report. “The increase in imports is across the board and not just limited to oil and gold, as is conventionally thought.’’
The rising volume of foreign capital seeking growth and yield could push up India’s commodity prices. High asset prices may mean strengthening of the rupee and possible loss of export competitiveness, in addition to widening the current account deficit. Exports to the US and European Union, 30 per cent of India’s total merchandise exports and a larger proportion of services exports, are likely to remain weak because of subdued demand.
Still, any reversal of capital flows for an extended period could lead to sell-offs in currency, equity and bonds, causing a liquidity crunch. However, the possibility of reversal for an extended period remains a risk and not a danger, since India has adequate foreign exchange reserves to counter a temporary reversal of capital, conceded the report.
Adding: “Yet, the increased reliance on external capital to fund the ever-wider current account deficits has increased vulnerability significantly, more than before the 2008 crisis.’’
