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With the nosedive of the rupee, India’s current account deficit (CAD) has entered the lexicon of the lay newspaper reader.

In simple terms, India’s CAD calculated for 2012-13 is $90 billion (approximately 4.8% of India’s $1,850 billion annual nominal gross domestic product, or GDP). This, in turn, comprised a merchandise trade deficit (MTD) of $195 billion, and a surplus in what economists call invisibles—made from the services industry and annual diaspora remittances of about $105 billion—resulting in the $90 billion difference. That difference has to be funded by foreign direct investment (FDI), foreign portfolio flows and short-term credit borrowings in the international markets. When the market fears that the foreign funding may not be forthcoming (as they began to do on news of the US Federal Reserve tapering its easing programme), the rupee wobbles.

So the real culprit in the deterioration of the Indian CAD is the MTD, which has risen from about 5.5% of GDP in 2004-05 to about 10.5% now. This MTD arises because of a deficit in manufactured goods (about $50 billion) and a sharp rise in the imports of two items—gold and oil—which together have risen to make for an import bill of about $200 billion today. Had these deficits as a percentage of GDP remained at 2004-05 levels, there would be a manageably small CAD of about 1.5% of GDP. Enough numbers.

India’s recent rupee disaster comes about because we have a manufacturing sector that is not globally competitive and also because our citizens have a fetish for gold and (subsidized) imported oil. The rupee’s fall is an adjustment to a new world order of higher real rates in emerging markets, which is a direct consequence of normalizing rates in the US. The rupee will not return to its old levels without significant productivity improvement in the Indian economy.

The Reserve Bank of India (RBI) and the ministry of finance (MoF) have been moving the deck chairs on the rupee Titanic. Most of the measures announced last week—putting a cap of $75,000 per person on foreign exchange that can be remitted, an increase in the duty on flat screen televisions, reduction in the cap for automatic permission for investment abroad—are meaningless because they contribute almost nothing to today’s CAD. The increase in gold duties to 10% does bite and may have some impact, but a gradual increase in duties, rather than a one-shot move right at the beginning has possibly blunted its effect.

What can be done now?

The depressing but simple answer in the short run is, not much. RBI does not have enough firepower to defend a particular value of the rupee (assuming the international environment remains what it is), and the MoF has really no set of effective tools (adding friction to capital outflows apart) that will impact the rupee. But much can be done in the long term. For lasting effect, RBI and MoF need to concentrate their efforts on the MTD. An explicit goal to return the MTD to 5% of GDP will serve to focus the minds of policymakers.

The manufacturing industry in India, such as it is, just got a great deal more competitive in rupee terms because of the 40% depreciation over the last couple of years. That is precisely how a flexible currency ought to adjust to improve a deteriorating CAD. Beyond that, the government should focus on the enablers for manufacturing—electricity, roads, ports, telecommunication and credit—instead of sops or a prescriptive industrial policy. Of these, electricity and credit are most important. RBI, in particular, can play a role in establishing a robust corporate bond market in India. This has fallen between the cracks at RBI and the Securities and Exchange Board of India (Sebi) and has been a costly laggard.

The most important thing to do to reduce oil imports is to eliminate oil-related subsidies. It is imperative that a proper market price be established for all petroleum products.

Only free market prices will establish true demand. Subsidies, if required, can be handed to targeted customers as cashback. For the longer term, the government needs to put out an effective shale gas policy quickly and begin exploration.

Asset allocation towards gold is a rational response in a stagflationary environment. Collectively, we need to create alternative destinations for savings that provide attractive real returns over time. Investing in the stock markets, with negative nominal returns over the last three years, or in fixed income markets with meagre real returns has not been an attractive alternative. Keeping the economy growing well and with moderate inflation is the best way to make financial assets as good as gold to the investor. It is often said nowadays that the rich in India have seceded from a nation that has dramatically “underachieved its potential". The middle class cannot afford to secede, but their vote for secession is cast by buying that ounce of gold.

PS: “The desire of gold is not for gold. It is for the means of freedom and benefit," said Ralph Waldo Emerson.

Narayan Ramachandran is chairman, InKlude Labs. Comments are welcome at

To read Narayan Ramachandran’s previous columns, go to

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