New Delhi: India should discourage unproductive imports such as gold and consumer durables to check the country’s rising current account deficit, the finance ministry said in its annual Economic Survey.
The survey for 2011-12, which was presented in Parliament on Thursday, also expressed concern over the impact of the liberalization of the external commercial borrowing (ECB) policy on India’s external debt situation.
India’s current account deficit increased to 3.7% of gross domestic product (GDP) in the second quarter of the current fiscal from 3.5% in the first quarter, indicating progressive deterioration. In the first six months of the current fiscal, the nation’s external debt rose $20.2 billion to $326.6 billion, as of 30 September.
The increase was driven by higher commercial borrowings and short-term debt, which together accounted for more than 80% of the increase in external debt during the period.
“High trade and current account deficits, together with high share of volatile FII (foreign institutional investor) flows, are making India’s balance of payments vulnerable to external shocks,” the survey said. “A trade deficit of more than 8% of GDP and current account deficit of more than 3% are a sign of growing imbalance in the country’s balance of payments.”
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India is the world’s largest importer and consumer of gold. After fuel, gold is the most imported commodity, contributing to more than 13% of India’s imports in the first half of the current fiscal. India in January decided to link the import duties on gold and silver to the prices of these commodities, a move aimed at curbing gold imports.
“Gold imports are unproductive and lead to a substitution of financial savings with physical savings,” said D.K. Joshi, chief economist at rating company Crisil Ltd. “But stopping gold imports may only encourage smuggling.”
Though the rupee’s depreciation against the dollar in the past few months has improved the competitiveness of India’s exports, the euro zone crisis is expected to further slow exports in the coming months, the survey said. This, coupled with only a slight moderation in international oil and gold prices, is expected to further widen the country’s trade deficit, it said.
“Exports are likely to grow slowly in the coming months. On the other hand, import growth may only moderate with oil prices still above the $100 per barrel mark and gold prices still at a high of $1,745 per troy ounce as on 8 December 2011,” the survey said. India’s trade deficit in April-January 2011-12 was at an all-time high of $148.7 billion, according to government data.
The survey also pointed out the need to improve the share of foreign direct investment in total capital flows to reduce reliance on volatile short-term capital flows. “When the global environment is uncertain, financing of the current account deficit will always be a problem due to the reliance on volatile capital flows,” said Joshi.
India’s current account deficit is expected to cross 3.5% of GDP in the current fiscal, according to economists.
“In 2012-13 also, current account deficit is expected to be around 3.5%. But if economic growth picks up, this could go up further as imports will increase,” Joshi said.
The survey also suggested the need for a more aggressive approach to check volatility of the Indian currency.
“Such volatility impairs investor confidence and has implications for corporate balance sheets and profitability in case of high exposure to ECBs when currency is depreciating,” it said.
The survey has also warned that an increase in overseas borrowings by companies will increase the debt service burden and affect the profitability of borrowers, and lead to a potential balance of payments crisis.
ECBs nearly doubled to $10.6 billion in the first half of the current fiscal from $5.6 billion a year earlier.
“An important reason India emerged largely unscathed from the global crisis of 2008 is the strict ECB policy that places all-in-cost, end-use and maturity restrictions on foreign borrowings by corporates. The liberalization of ECB policy, as a result, has to keep in view the need to maintain sustainable levels of external debt ratios.” The Reserve Bank of India had liberalized the ECB policy last year by increasing the borrowing and all-in-cost ceiling limits, which include the rate of interest, other fees and expenses in foreign currency.
“A problem with servicing debt only surfaces when the overall economic environment is not good and exposes the vulnerability of the corporate sector,” Joshi said. The survey advocated building up the country’s foreign exchange reserves when the economy sees good capital inflows. India’s foreign exchange reserves covered 95.4% to the country’s total external debt on 30 September, compared with 99.5% on 31 March.