The latest quarterly balance of payments data released by the Reserve Bank of India (RBI) show that the current account deficit, or CAD, rose sharply for the quarter that ended in December 2011. In the three months of October, November and December 2011, CAD was 4.3 per cent of gross domestic product (GDP), a full two percentage points higher than the figure for the corresponding quarter the previous year. A fortnight ago, the Prime Minister’s Economic Advisory Council had estimated that CAD for the entire fiscal year 2011-12 would be at 3.6 per cent of GDP — which it had been for the first six months of the fiscal year. These new figures would seem to suggest that meeting that target, considerably higher than earlier projections, will be difficult. Meanwhile, the fiscal deficit continues to be severely stressed. Even according to the Union Budget’s projections, it is unlikely to come down sharply for the remainder of this calendar year, and the big sums expected from the spectrum auction won’t come in immediately. Together, the twin deficits create a level of vulnerability for India that should be a cause for concern.
Why has India been allowed to reach this level of vulnerability? After all, the suggested cap for CAD is at two per cent of GDP, and India, overconfident of its reserves, has soared past that level. There has been a certain optimism that India’s foreign exchange reserves will prevent any recurrence of a 1991-style crisis. However, reserves decreased substantially over the quarter ended December 2011, said the RBI: “capital inflows fell far short of financing requirements resulting in significant drawdown of foreign exchange reserves.” More to the point, crises do not emerge predictably. A sharp, unprepared-for spike in oil prices – as could occur following a military confrontation in West Asia involving Iran – would, given the weakness of India’s twin deficits, pose a difficult challenge. India’s exports have noticeably weakened, while its appetite for imports has flourished undiminished. A weakened rupee has allowed remittances, although less than expected, to nevertheless help plug the gap.
Policy makers in New Delhi cannot but be aware of this problem. It is far from certain, however, that they have drawn the correct conclusions about how to fix the problem. Taxing gold imports might help, and at least has the possible justification that household savings could be more productively employed elsewhere. However, shortly after the Budget, the finance secretary warned: “If we cross a CAD of 3.5 per cent, we need to see which imports can be curbed without adversely impacting growth.” UPA-II’s reflex towards controls and curbs is not a solution, it is the problem. The only real solution is to raise competitiveness and India’s attractiveness as a destination for capital — and not for temporarily risk-friendly institutional investors either, but for actual, on-the-ground investment. For this, less government control, liberalisation of foreign direct investment rules in sectors such as retail, and a more predictable tax system are central. There can be little doubt that the government has lost a public relations battle on that front over the past year in particular. It must not compound the problem by further clumsy attempts at imposing discretionary controls.
