Caging the cur­rent ac­count deficit

Mint Asia ST - - Views Theirview - Dhar­makirti Joshi and Pankhuri Tan­don

It

smells like 2013 all over again, with a bal­loon­ing cur­rent ac­count deficit (Cad)—higher goods trade deficit has off­set buoy­ant remit­tances from abroad and a pos­i­tive ser­vices trade balance—and a free fall in the ru­pee’s value ver­sus the dol­lar. That said, the sit­u­a­tion to­day is quite dif­fer­ent from 2012 and 2013 when CAD was over 4% of the gross do­mes­tic prod­uct (GDP), in­fla­tion was kiss­ing 10%, and fis­cal deficit was over 4.5% of GDP. Even a men­tion of a likely ta­per­ing of bond pur­chases by the US Fed had sent the cur­rency on a tail­spin, los­ing over 25% in a mat­ter of months.

To­day, these in­di­ca­tors are at much lower lev­els—cad at 2.4% of GDP in Q1 of this fis­cal, in­fla­tion at 3.7% in Au­gust, and fis­cal deficit at 3.5% of GDP in fis­cal 2018.

Be­sides, In­dia is less vul­ner­a­ble in terms of macroe­co­nomic health as well as its abil­ity to fi­nance short-term obli­ga­tions such as CAD, short-term ex­ter­nal debt and long-term ex­ter­nal debt payable in the next one year us­ing its forex re­serves. So, what’s caus­ing the ru­pee to bleed?

Look­ing closer, we see the global shocks are much big­ger in quan­tum and com­plex­ity this time and have shrunk the cap­i­tal in­flows. The econ­omy is reel­ing un­der a triple whammy—first, ris­ing global oil prices; sec­ond, ris­ing in­ter­est rates in the US (the 10-year gov­ern­ment bond yields have risen to over 3%) and the quan­ti­ta­tive tight­en­ing un­der­way (the Fed balance sheet is shrink­ing by $50 bil­lion per month); and third, in­creased trade pro­tec­tion­ism around the world.

Be­sides, coun­tries with high CAD get hit more in a global sell-off sce­nario. And In­dia’s CAD, af­ter de­clin­ing to 0.7% of GDP in fis­cal 2017, rose to 1.9% in fis­cal 2018, and could cross 2.6% of GDP this fis­cal. Given the global shocks, the at­ten­tion has shifted to rein­ing in CAD and im­prov­ing its fi­nanc­ing con­di­tions. We sam­ple here some po­ten­tial short-term steps to help re­duce CAD.

Al­low­ing the cur­rency to weaken and im­pos­ing im­port tar­iffs qual­ify as ex­pen­di­ture-switch­ing poli­cies, as these are in­tended to re­duce im­ports and shift con­sump­tion to­wards do­mes­tic goods. No­tably, the ru­pee has weak­ened over 14% against the dol­lar this year. As for im­port tar­iffs, In­dia re­cently raised duty on a range of items in­clud­ing air-con­di­tion­ers, re­frig­er­a­tors, wash­ing ma­chines and footwear. How­ever, im­port tar­iffs should be avoided as far as pos­si­ble as these dis­tort trade and have a lim­ited pay-off.

For ex­pen­di­ture re­duc­tion, fis­cal rec­ti­tude be­comes im­por­tant. So far, the gov­ern­ment has an­nounced its re­solve to main­tain the fis­cal deficit at 3.3% of GDP as en­vis­aged in the cen­tral bud­get and, as of Au­gust 2018, the fis­cal sit­u­a­tion was bet­ter than last year. How­ever, fis­cal con­trol will be a chal­leng­ing task in a pre­elec­tion year where im­ple­men­ta­tion of an­nounced min­i­mum sup­port prices and newly an­nounced health scheme could put ad­di­tional pres­sure on ex­pen­di­tures.

In such a sce­nario, it serves well to pass on the global crude price in­creases to the con­sumer, which the gov­ern­ment was do­ing un­til re­cently. The gov­ern­ment fi­nally de­cided to re­dis­tribute the bur­den of ris­ing crude prices, which in­volves a fis­cal cost of 0.05% of GDP and hit to fi­nances of oil com­pa­nies. Ris­ing in­ter­est rates, mean­while, will help curb do­mes­tic de­mand and the Re­serve Bank of In­dia (RBI) has raised the repo rate twice by 25 ba­sis points each this year in re­sponse to in­fla­tion threat. How­ever, RBI tar­gets in­fla­tion and does not de­fend the ru­pee at any par­tic­u­lar level. It made it clear in its re­cent pol­icy that it only acts to con­trol volatil­ity in cur­rency mar­ket.

Over­all, these de­vel­op­ments may not dent CAD suf­fi­ciently, es­pe­cially if the oil prices keep ris­ing. How­ever, ad­dress­ing do­mes­tic bot­tle­necks can help. Here, a look at spe­cific sec­tors is quite in­struc­tive. Crude and gold are typ­i­cally seen as cul­prits. With­out doubt, ris­ing crude oil im­port bill is a dom­i­nant rea­son for bloat­ing trade deficit. In­ter­est­ingly, how­ever, the share of crude oil im­ports at 23% of to­tal im­ports in fis­cal 2018 is much lower than the 33% it was in fis­cal 2013. The share of gold im­ports in to­tal im­ports has fallen to 7% from 11% over this pe­riod. On the other hand, the share of ores and min­er­als (es­pe­cially coal), elec­tron­ics and agri­cul­tural im­ports in to­tal im­ports has been ris­ing.

There is some op­por­tu­nity to ex­pand agri­cul­tural trade in the short term, par­tic­u­larly with China. In fis­cal 2019 so far, In­dia’s ex­ports to China have grown an aver­age 52.9% year-onyear, com­pared with 14.7% to the US, 11.9% to UAE and 12.6% to Europe. While In­dia’s over­all trade deficit in­creased by $14.4 bil­lion dur­ing April-au­gust 2018, its trade deficit with China shrunk by $2.8 bil­lion.

Com­ments are wel­come at theirview@livemint.com

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