THE ECONOMIC TIMES
11 Apr, 2012, 10.41AM IST, Gayatri NayakGayatri Nayak, ET Bureau
India the only country in Asian region with current account deficit
For nearly three years, every policy-maker has been claiming credit for India escaping the misery caused by the 2008 credit crisis due to the deft handling of the situation by administrators. Now, a crisis is brewing that is making many recall the year 1991 when India pledged gold to save its skin.
The current crisis, however, is not due to any global shock, but is mostly the doing of policy-makers. Alarm bells are not ringing yet in the corridors of Raisina Hill, but there are murmurs on Mint Street after the Reserve Bank of India released the quarterly balance of payments report on March 30. For the first time since Lehman Brothers collapsed, the balance of payments fell into the deficit zone. The current account deficit (CAD) - the net position of cross-border trade and services - crossed 4% of the gross domestic products (GDP), when 3% is considered to be the 'lakshman rekha'.
These times are eerily similar to the worst the nation faced in more than two decades - at least economically. But the cacophony over the slowing economic growth rate, taxes and corporate profitability is drowning what should have been the hot topic of debate - worsening external balances.
This is not 1991. Indian economy is many times bigger. Trade is up multiple times. Actors are many and instruments are numerous. However, the impact of the worsening situation will probably be more severe than it was in the gloomiest days since the state occupied the commanding heights of the economy.
"In 1991, the global situation was relatively more reassuring," said Samiran Chakraborty, head of India Research, Standard Chartered Bank.
"But, now, India's openness has increased substantially. So, in that sense, any shock in the global economy will have a large impact on the domestic sector. Hence, we are kind of worried about the balance of payments despite numbers being relatively better than 1991." Two decades ago, the current account deficit was close to 4% of GDP due to a sharp rise in the import bill driven by surging oil imports, among others. Crude prices surged because of the Middle-East crisis.
With demand being price-inelastic, curtailing imports was difficult and, at the same time, exports, too, were slow to rise. The government depreciated the rupee by 24% in a matter of three days to regain the export competitiveness. It borrowed $2.2 billion from the International Monetary Fund and pledged 67 tonnes of gold with Bank of England and the Union Bank of Switzerland and raised another $600 million, since there were no foreign investments flowing in.
Twenty-one years later, the discussions among economists, currency traders and experts are almost similar. Are we into the next big crisis?
Two factors are converging to whipsaw investors and the economy - there is extraordinary demand for goods from an overheated economy, and exports growth is slowing as Europe and the US are still crawling back to growth. "If it does not adjust, then we are in for another round of depreciation," said Abheek Barua, chief economist at HDFC Bank. The Indian rupee, which was the best performer in the first two months of the year, has surrendered half the gains and will probably end a loser if overseas fund flows do not improve. There are already calls for some special schemes like the once famous Resurgent India Bonds, or the India Millennium Bonds - which, by itself, is an indication that the economy is almost where it was in the early 1990s.
Balance of payments, a record of trade in goods, invisible services and capital flows into and out of the country, ended in a deficit of $12.8 billion in the December quarter. The current account deficit, the excess of imports of goods and services over exports, touched $19.4 billion. The nation had to draw down from reserves to meet its consumption- a sign of weakness.
"To counter this, the RBI and government will have to step up capital inflows - targeted NRI schemes like IMD, fast-track clearance of FDI proposals, easing ECB norms are options," said Barua. India is no longer insulated from the global troubles. The fiscal troubles in the Euro area are again threatening the global economic outlook and, this time around, India's growth story is slowly starting to get a nasty twist. From 9% growth of over three years prior to 2008, the economy is projected to grow at 6.6% in FY12.
The economic fundamentals are slowly slipping. High inflation and volatile manufacturing and service numbers are threatening the economy's growth. Besides, an open economy is making us more vulnerable, not only to global demand, but also global inflation, adding more challenges for the external sector stability. There was some solace from foreign exchange reserves, but the comfort is waning as the import cover of these reserves has steadily come down over the past few months to fund about six months' imports.
"As India runs a large current account deficit in a fragile global environment with unresolved problems in Europe, it is exposed to the risk of capital outflows and a consequent volatility in the rupee," said DK Joshi, chief economist at Crisil. The only long-term option is to improve the export competitiveness as imports, mainly because of oil and gold, will remain inelastic. "Intrinsic assumption is that imports are inelastic," said Standard Chartered's Chakraborty.
"So, the only way to address current account deficit is to increase exports. There are no immediate solutions. Over the medium-term, one could look at improving competitiveness of exports by letting the currency depreciate. We will also have to improve the quality of our exports by increasing our value-added exports, besides looking for new markets."
There are talks that gold imports need to be considered as capital account transactions. But the whole issue is that if you look at dollar demand and supply, then gold import, whether it is current account or capital account, the pressure on the rupee will continue. "We think the RBI's policy on rupee needs to return to the pre-2004 practice of building forex reserves even at the cost of a weak rupee," said Indranil Sengupta, India economist, Bank of America Merrill Lynch.
After all, the import cover has slipped to 1996 levels. The reserves need to be brought back to the pre-crisis levels of over $300 billion for a sustained period, he added. There are rays of hope with the US showing signs of sustained recovery, though the pace will be slow. Nevertheless, that's the light at the end of the tunnel for emerging markets which are being punished for fiscal profligacy.
Other efforts, such as rising investment limit on debt for overseas investors and a rise in duty on gold, could have some temporary relief.
"The CAD is likely to adjust to a range of 3.5% of GDP on the back of lower gold imports as the effect of tariffs kick in," said Barua of HDFC Bank. "The impact of fiscal consolidation and a natural process of import substitution has kicked in as the result of a depreciated rupee and volatility in the currency market.
If the US economy does recover, it will have a positive impact on both goods and services exports." But that's being on a wing and a prayer. Former RBI governor YV Reddy is fond of saying that the country acts and comes out with best solutions when in a crisis. Is it that time again in the life of this nation?