India’s deficit — not just about oil and gold
India’s finance minister P Chidambaram can be forgiven for feeling cheerful. After all, prices for oil and gold, the two biggest constituents of his country’s import bill, have tumbled sharply this week. If sustained, these developments might significantly ease India’s current account deficit headache — possibly to the tune of $20 billion a year.
Chidambaram said yesterday he expects the deficit to halve in a year or two from last year’s 5 percent level. Markets are celebrating too — the Indian rupee, stocks and bonds have all rallied this week.
But are markets getting ahead of themselves? Jahangiz Aziz and Sajjid Chinoy, India analysts at JP Morgan think so.
Chinoy and Aziz acknowledge that India could shave up to $25 billion off its annual import bill if commodity prices do continue falling. They warn however:
Relying on falling global commodity prices – over which policymakers have absolutely no control — to alleviate India’s external imbalances is tantamount to living on a wing and a prayer. Falling commodities will undoubtedly help this year’s current account deficit but cannot be a “plan” or “strategy” for sustained reduction.
Even if the price correction sustains, this is unlikely to translate into an equivalent reduction of the deficit.
Why not? A closer look at some of the factors that are troubling JPM.
First, coal imports are on course to double from two years back as domestic output lags electricity generation, they note, adding that imports could rise another $3-4 billion over the coming year. Second, iron ore production and exports have collapsed due to mining bans in some Indian states — exports are estimated at $1.5 billion this year from $6 billion 3 years ago. Meanwhile, with no iron ore production at home, imports of scrap metal have almost doubled over 3 years.
Finally, JPM say there has been little attention paid to the rate at which foreign investors are repatriating profits from India. (see their graphic)
In itself this is not a sinister phenomenon — examples elsewhere show that as the FDI stock grows, repatriation of returns tends to weigh on the current account. What is worrying in India is the scale and pace of repatriation — Chinoy and Aziz point out that net profit repatriation from India has tripled from $4 billion in 2010 to $12 billion in 2012 and the deterioration in net investment income outflows has been almost 1 percent of GDP over the last 5 years. They add:
The non-linear manner in which (repatriation) has accelerated during the very years in which the investment climate has weakened, macroeconomic uncertainty has risen, and concerns about currency depreciation have renewed, suggests that it is related to the policy and investment climate in India…what’s more things could get worse before they get better.
In sum, they expect all these phenomena to widen the current account deficit by $14 billion, more than offsetting the savings made on oil and gold.
Chidambaram will be aware of all this. He told Reuters yesterday that his main aim now is to deal with the “last mile” bottlenecks — fuel supply, environment clearance, forest clearance, land acquisition — some of the factors plaguing the economy and FDI outlook. India-watchers will be praying he succeeds.