Off the balance in external payments
(The views expressed in this column are the author’s own and do not represent those of Reuters)
It always takes time for the government to wake up to any emerging problem; and when it does, the problem is already magnified. That is what’s going to happen to the balance of payments.
The trouble is really with external trade. We are importing far too much and exporting far too little thereby building up a huge trade deficit. Of course, there are reasons, some beyond control. We cannot export enough because the importing countries are in and out of recession, burdened also with high unemployment. That is so of the U.S., Europe and Japan which together account for more than a third of our exports. Last February, exports increased a mere 4 percent in spite of the depreciation of rupee against dollar by 13 percent.
Our imports increased much more than exports though the rate of growth of industrial production actually slumped. There was a 41 pct increase in imports of oil mainly because of the jump in oil prices following political disturbances in the Middle East. Had these prices been passed on, consumer demand would have shrunk and imports of oil checked. Instead, the government allowed subsidies to rise and create larger demand and consequently larger imports of oil. We produce only a quarter of our oil requirements. But we have enough coal and yet we import coal also because Coal India’s production has been stagnant.
The result? A trade deficit of $47.7 billion in Oct-Dec 2011. Surely, we have a favourable balance on invisibles account. Exports of services are higher; so also the inflow of remittances. But the huge trade deficit could not be covered by the small increases in invisibles. The current account deficit in Oct-Dec consequently climbed to $19.6 billion, more than 4 percent of the GDP.
That is a danger zone. Even a 3 percent deficit unnerves the ratings agencies and does not at all humour foreign investors. It questions the solvency of the government for foreign exchange payments and forces the rupee to depreciate. That reduces the return in dollar terms and consequently foreign investment, creating a vicious circle which can precipitate a crisis.
The last budget did everything to aggravate the problem. The introduction of GAAR and the retrospective changes in tax laws have added uncertainty to tax liability. That will adversely affect foreign investment — both direct and equity — leave the current account deficit uncovered, and force the RBI to draw down foreign exchange reserves. In the last 12 months the reserves had dropped $14.2 billion and will drop further with a large part of foreign debt being short term.
In the Oct-Dec quarter, the inflow of foreign investment was short of the current account deficit and consequently the balance of payments was negative for the first time since the global crisis of 2008. No wonder the RBI has been concerned. But it is really for the government to act with urgency to generate investor confidence and prevent a run on foreign exchange reserves with hot money outflow.