In his magnum opus, The Story of Civilization, which ran into 11 volumes, American historian Will Durant wrote:

“When the Hindu could not invest his savings in his own economic enterprises, he preferred to hide them, or to buy jewellery as conveniently hoardable wealth." (Vol.I, Chapter XVII).

In the first six months of 2011, India ran up a merchandise trade deficit of $65.4 billion. For some strange reason, the Indian authorities classify gold imports under merchandise imports, although, for all practical purposes, it is a capital account transaction. It is equivalent to Indians buying an overseas asset. Its impact might be the same in terms of cash flow or liquidity, but in terms of the trade deficit optics, it has a crucial role to play, as we shall see below.

Rather simplistically, let us extrapolate the first-half 2011 trade deficit into an annual deficit of $130.8 billion. That works out to 7.5% of GDP. It appears large. Now, let us figure out how much of it is caused by gold imports. India imported 753 tonnes of gold in the first nine months of the year, according to the World Gold Council. Now, let us estimate that the total gold import for 2011 would be “only" 900 tonnes. Anecdotal evidence suggests that gold imports by Indians declined markedly in October and November. At an average 2011 price of $1,571.5 per ounce, this translates into $45.6 billion. That is more than one-third of the trade deficit. In other words, gold imports are about 2.5% of GDP.

India’s current account deficit, even if one were to be conservative, will not exceed 3.5% of GDP for 2011. Now, if one took out gold imports, the current account deficit is about 1% of GDP. Absolutely normal and even desirable for a developing nation. In fact, when Western nations want Asians to consume more, thus providing a market for their exports, India is doing that job and the foreign exchange market is punishing India for that.

Certainly, the optics from India have not been good this year. The government is paralysed. A half-hearted reform measure initiated by the government recently got shouted down in true Indian style. GDP growth in the third quarter has dropped below the magical 7% and the government admitted that it had overstated exports by $9 billion this year. None of this is positive for sentiment. But none of this warrants a 22% appreciation in the dollar against the rupee in barely four-and-a-half months.

India needed a wake-up call after taking economic growth for granted and having run up a huge government debt thanks to its utter indifference to the fiscal deficit and to the quality of its fiscal spending, more importantly. Further, the fact that Indians still park their savings in gold suggests that their trust in financial assets is low. Economic reforms will not only accelerate economic growth, but will also create trustworthy choices in financial assets for household savings. That would reduce capital outflows. That has not happened yet. To that extent, an underperforming rupee was a reasonable outcome. But, given the “true" current account deficit of just around 1% of GDP, the rupee’s devaluation is unquestionably excessive.

The Reserve Bank of India (RBI) has announced restrictions on forward currency trading. They will work. On Friday, it left its monetary policy unchanged. It was a sensible decision. It cannot afford to cut rates when the Western policymakers still have their fingers on the “print" button. It is a matter of time before they press hard on it. That could push up the price of oil. Therefore, cutting rates would have been premature. Dropping the cash-reserve ratio might have helped improve domestic liquidity, but its impact on the rupee is unpredictable. Now, we can have a bit more sympathy for the International Monetary Fund (IMF).

IMF used to want governments in crisis countries to hike rates at a time when economic slowdown/crisis had squeezed domestic liquidity. Sure enough, it worsened the economic situation, but it used to arrest currency depreciation without which external liabilities would become too onerous. So, it is worthwhile to remember that all alternatives have painful and unpredictable trade-offs.

India needs a few quarters of sub-7% growth (potential growth estimate is put at 8% by RBI) for inflation to come down. As the global economy skids in 2012, India might be better poised to weather it with an inflation trough, a super-competitive currency and a chastened polity. Maybe, it is too optimistic to count on the last, but Bare Talk is happy to deviate from the script, for once. See you in the “Year of the reckoning".

V. Anantha Nageswaran is a senior economist with Asianomics. These are his personal views. Comments are welcome at

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