The country’s current account deficit (CAD) has been reported at an alarming 6.7% of the GDP for the third quarter of FY2013. This amounts to over $30 billion and means that we need capital flows to this extent in order to fund this deficit. If capital flows fall short, then either our currency depreciates or the Reserve Bank of India (RBI) uses its foreign currency reserves to bridge the gap.
Indeed, the rupee has depreciated steadily while the RBI’s reserves have declined. The good news is that given the high level of reserves held by the RBI (over $300 billion at its peak) we have enough reserves even now to cover our liabilities. Foreign capital inflows have also been adequate to cover the deficit and the rupee has tended to appreciate at times.
So while we have tided over the difficult period, such a high CAD is clearly not sustainable. The data shows that there was a sudden surge in imports in the third quarter and even though there was some turnaround in our exports, the trade deficit increased sharply. In contrast, the net surplus on services trade increased due to a contraction in imports. Other categories including net transfers into India and income payments abroad both declined a bit, increasing the deficit. The main culprit is a rise in imports, and among imports it is oil imports that have increased sharply. During April 2012 to February 2013, while oil imports have increased by about 12%, non-oil imports have declined by 5%. This indicates that it is critical to have a strategy to curb oil imports. The government’s action to limit fuel subsidies by slowly raising the price of fuel products is a step in this direction. It would be difficult to justify a fuel subsidy when the need of the hour is to cut down our consumption of fuel products. A 5% saving in our oil consumption could cut down our import bill and reduce our current account deficit by about $8 billion.
The other major import is gold, where it is evident that the government’s earlier action to raise import duties is having some impact. During April 2012 to February 2013, imports of gold and silver have declined by 7.5% compared to the previous year, although they still account for 11.7% of our import bill. Given that these do not have any productive use, they should be drastically reduced. However, we know from our earlier experience that this cannot be achieved by simply banning imports or imposing very high duties, which would simply encourage smuggling. We need to develop alternative saving instruments that are perceived to be safe and that provide good returns on an inflation-adjusted basis.
Ultimately, we need to ensure that our products are competitive in order to increase the market share of our exports and to curb imports. Rising domestic inflation has made India a high-cost economy even as weaknesses in our infrastructure remain a constraint on our competitiveness. The RBI’s indices of real effective exchange rate indicate that the rupee has appreciated on an inflation-adjusted basis against a basket of currencies. This needs to be corrected through some moderation in inflation.
We can learn from countries such as South Korea or China, which have put in a lot of effort to develop a strategy for promoting their exports. These countries developed a low-cost export base by providing excellent infrastructure and various incentives. In contrast, India’s Special Economic Zones are losing sheen due to imposition of taxes. The micro, small and medium enterprises, which have been the biggest contributors to our exports, face various constraints in growing and achieving scale. The incentive schemes available to exporters are cumbersome and time-consuming and involve multiple agencies. Indian exporters continue to pay indirect taxes and levies, which are not fully refunded to them.
At a macro-economic level, the rise in the CAD reflects imbalances in an economy where demand far exceeds supply. Excess spending by the government and a fall in government savings has led to a rise in the CAD. Therefore, a reduction in the government’s fiscal deficit is an important step for reducing the imbalance. It is critical to achieve the fiscal consolidation planned by the government. With the steps already taken by the government, the CAD is likely to moderate from its peak. However, fundamental changes to make the economy more competitive are required to achieve sustained moderation.
Chandrajit Banerjee is director general, CII
The views expressed by the author are personal