It’s been three years since the ‘taper tantrum’ of 2013 stressed India’s current account deficit (CAD) and sent the rupee in a free-fall against the US dollar. We’ve come a long way since then. Let’s first take a look at the breakdown of the current account deficit.
The current account broadly measures a country’s position in external trade. It is the total of net merchandise (or exports minus imports) and invisibles (trade of items you can’t see like software exports). When the total of invisibles and merchandise is negative, it results in a current account deficit, as is the case in India. Put simply, this means that India imports more than it exports. A CAD of around 1-2% of GDP is normal since India is also growing at a robust pace and also attracts foreign capital. However, our biggest source of strain on the current account remains crude oil. Since we don’t produce enough for our consumption, we need to import crude oil. Another source of high imports is gold – our nation’s obsession with gold is legendary and, again, we have to import gold to satisfy our large demand; although, in all fairness, our gold demand has come down compared to the past. Our biggest exports are petrochemicals, agriculture, leather, jewelry, pharmaceuticals and a whole host of smaller items. Another big support to our current account deficit comes from ‘remittances’ – or money remitted by Indians abroad, back to India. A big chunk of these remittances come from Indians staying in the Middle East.
Rewind to 2013. In May 2013, then US Federal Reserve (‘Fed’) Chairman Ben Bernanke said that the Fed would “take a step down in our pace of purchases (of US Treasury Securities).” This statement sparked off ‘taper tantrum’ – or the market’s panicked reaction (hence tantrum) to the Fed’s plans to reduce (hence taper) its liquidity support to the US markets. In the next few months, equities sold off (India’s Nifty lost nearly a 1000pts), the Indian rupee weakened (from Rs55 to Rs68 to the US dollar) causing plenty of turmoil. Raghuram Rajan took over as Governor the RBI in September 2013 and took control of the situation. Among the many measures taken were allowing banks to issue NRI deposits to attract US dollars into India. These measures worked and by March 2014, India’s current account deficit had fallen to 1.7% of its GDP from precipitously high levels of 4-5% in FY12-13. The rupee also responded favorably to these measures, coming off the then all-time high of Rs68.36 in August 2013 to Rs60 in the following year.
The latest release of trade data from the RBI shows that in FY16, India’s current account deficit stood at a comfortable 1.1% of GDP. The fall in crude prices, from $100/barrel in mid-2014 to less than $30/barrel in January 2016, has been the single biggest driver in reducing our imports bill. To put things in perspective, India’s total imports stood at $502billion in FY13 and from there, they fell to $396bn in FY16, driven mainly by the fall in crude oil prices. Not everything is good news though. As you would expect, the global slowdown has also hit India’s exports, which have fallen from $307bn to $266bn during the same period. A fall in crude prices also drives a fall in remittances (since Middle Eastern incomes are linked to oil prices) and these have also been impacted. But overall, India has benefited tremendously from the fall in crude prices and this can be seen from the fact that, at 1.1% of the GDP, India’s CAD was the lowest since FY08 (when it was 1.3%) – that’s an eight-year low.
Will India’s CAD hit a new low in 2016?
No. Things won’t be as good, but they won’t be too bad either. Here’s why:
1. Crude prices have already bounced back from $27/barrel to current levels of $49/barrel. This increase will eventually hit India’s import bill. Will crude prices fall back to below $30/barrel? Unlikely. Moody’s Investors Services recently raised its crude oil price forecasts to $40-60/barrel in the medium term. This range is manageable for India. Minister of State, Jayant Sinha had recently said that "If oil prices stay in the range that most forecasters are expecting them to be, which is $40-60, we will be fine. If it goes beyond that range, then it becomes a question,"
2. Exports are stagnating dangerously. In May 2016, India’s merchandise exports fell for the 18th month in a row – a long streak of decline. The recent rise in crude prices will also benefit our exports, but structurally, more needs to be done to improve India’s competitiveness in global trade. Minister of State, Commerce and Industry, Nirmala Sitharaman, stated that she expects a slow and steady rise from here on.
Hold your breath this week though, as Britain prepares to leave, or stay, with the European Union. Markets are keenly watching for the results of the referendum and its impact on the European (indeed, global) economy, currency rates, treasury yields and much more. In case Britain decides to leave, you can expect another bout of global turmoil, similar to the taper tantrums. But this time around, India seems more prepared than it was three years ago.
Anupam Gupta is a Chartered Accountant and has worked in equity research since 2000, first as an analyst and now as a consultant. He contributes to the Business Standard platform, Punditry, through his blog, Beyond Markets on markets & the economic horizons.
He tweets as @b50
