Recent news from the external sector provides little respite for the Indian economy facing a slowdown for almost a year now. The current account deficit (CAD) of 3.1 per cent for the first quarter of FY 2012 (compared to 2.6 per cent during the corresponding period in FY2011) is largely due to a widening trade deficit and sharply higher external commercial borrowings (ECBs) by Indian companies. It is unlikely that the CAD will be capped below 3 per cent during the current fiscal, especially if global economic conditions do not change for the better. Despite the impressive increase in exports in recent months, the trade deficit widened because expenditure on imports exceeded export earnings. This trend will continue as long as the terms of trade are not in India’s favour. The recent increase in the proportion of short-term loans in total commercial borrowings is a cause for concern, though short-term debt is thankfully only 21.6 per cent of the overall external debt of $317 billion.
India’s current levels of forex reserves are adequate to cover any eventuality, though the Reserve Bank of India would certainly like to discourage uncontrolled borrowing, especially of short-term loans. Since aggregate demand in India is predominantly driven by domestic consumption and investment, GDP growth will not be significantly impacted. In fact, the CAD would have been a lot worse, had it not been for the sharp drop in commodity prices, especially oil, along with sharply increased quarterly remittance flows of $13.7 billion, representing a 4.6 per cent increase year-on-year. Hence, keeping an eye on the CAD/GDP ratio would be a good idea in these turbulent times.
The global economic slowdown is a double-edged sword: both commodity prices and exports will decline as a result of muted demand in developed economies. It is for this reason that software exporters are not overly enthused by the 11 per cent depreciation in the dollar value of the rupee! Another adverse impact of global volatility is sharply reduced investment flows, both of the direct investment and portfolio variety. Thus the ability of the capital account to mitigate a downside on the current account is likely to be limited in the foreseeable future. The situation becomes a lot more alarming when the recent government decision to borrow Rs 53,000 crore from the money markets is considered. This decision will certainly lead to higher interest rates and the subsequent ‘crowding out’ of the private sector, because of the increase in the cost of borrowing. It seems unlikely that the government will be able to adhere to its commitment to keep the fiscal deficit below 5 per cent of GDP. The simultaneous existence of current account and budget deficits will only increase dependence on foreign inflows of capital, which could eventually result in a much higher level of national debt. The trade deficit is unlikely to decrease because exporters cannot leverage the depreciation due to lower external demand, while the import bill will not decrease significantly. Given the uncertainties in global economy a wise government would focus its attention on improving domestic economic and fiscal management. Much more needs to be done by the government's top two — the prime minister and finance minister — to inspire greater confidence in the country’s macroeconomic management.
| A correction
The editorial comment “Early warning” (October 3) wrongly attributed the rise in India’s current account deficit (CAD) in part to higher external commercial borrowing (ECB). ECB is not accounted for in CAD but is reflected in the capital account. The error is regretted. |
