A weak external link

Higher macroeconomic risk could be the biggest challenge for India in 2013
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First Published: Tue, Jan 01 2013. 06 51 PM IST
Illustration: Jayachandran/Mint
Illustration: Jayachandran/Mint
Updated: Tue, Jan 01 2013. 07 01 PM IST
India’s current account deficit (CAD) for the second quarter of the current fiscal (July-September 2012) has reached 5.4% of the gross domestic product, perhaps the highest quarterly figure in recent memory. A CAD of this magnitude is unsustainable. The escalation in the deficit was primarily a consequence of combination of sharp decline in merchandise exports and relatively stable imports. While exports declined at a pace of 12.2% compared with the same quarter last year, imports merely decelerated by 4.8% on a year-on-year basis. Further, exports in the services sector also recorded lower growth during the quarter at 7.7% compared with 10.1% in the year-ago period.
Demand conditions in the global economy remain subdued while they are relatively robust in the Indian economy. Under these conditions, CAD is likely to remain elevated. Apart from restricting the size of CAD, which was at $22.3 billion in the quarter under review, financing it will be a big challenge. At the current rate, India needs capital inflows close to $7.5 billion per month, which virtually leaves the external account at the mercy of foreign investors. Although the liquidity situation in the global financial system remains comfortable, the desired pace of inflows may get disturbed due to a variety of reasons and are likely to pose serious challenges in currency management.
As a consequence, the balance of payments situation has emerged as another source of risk to macroeconomic stability. It is no secret that until the government deficit is cut drastically, the CAD position will not improve. Although the government made all the right noises on cutting expenditure, including those on subsides, decisive action is missing. Political considerations will continue to play a bigger role in decision making. Postponement of energy price adjustment will continue until matters get out of hand. That, however, seems to be India’s preferred path of macroeconomic adjustment.
Therefore, higher CAD combined with a higher fiscal deficit will keep uncertainty in the macroeconomic environment alive in the foreseeable future. Credit rating agencies, on their part, may not act immediately to downgrade India’s sovereign ratings. But these developments will increase doubts about India among foreign investors, making financing of CAD all the more difficult.
Therefore, with these numbers in sight, higher macroeconomic risk could be the biggest challenge for India in 2013.
Will balance of payments emerge as the biggest economic risk to India in 2013? Tell us at views@livemint.com
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First Published: Tue, Jan 01 2013. 06 51 PM IST
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