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 pre-election 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.
Let us look closer at two items where domestic policy (and not import tariffs) can play an important role—coal and agricultural trade. The trade surplus in agriculture has come down from $20 billion in fiscal 2014 to $2.1 billion in fiscal 2017. Despite some improvement in fiscal 2018 ($5.6 billion), it is still significantly below the peak and is one of the reasons behind the rising trade deficit. There is some opportunity to expand agricultural trade in the short term, particularly with China, which has been the top contributor to India’s export growth in recent months. In fiscal 2019 so far (April-August 2018), India’s exports to China have grown an average 52.9% year-on-year, 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. Indeed, cotton—on which China has imposed tariffs on the US—was among the top three contributors to India’s exports to China.
Similarly, India can look at the possibility of expanding its soybean and corn exports to China in the near term and policy authorities must facilitate this. Shortage of domestic coal supply, high premiums on domestic e-auction coal and reduced supply to non-power sector (such as cement, sponge iron and steel) has led to sudden spurt in imports, even when the international coal prices are at all-time high. Constraints to domestic coal production/ mining should be addressed on a priority basis.
To reiterate, the rise in CAD has been a result of both unfavourable global factors as well as domestic bottlenecks. The former is largely outside our control, but steps must continue at the domestic macro and micro levels to address the latter.
Dharmakirti Joshi and Pankhuri Tandon are, respectively, chief economist and junior economist at CRISIL.