Even as the Reserve Bank of India (RBI) frets over the
high rate of inflation and wards off pressures to cut interest rates, it
is faced with another challenge. Balance of payments data for the
second quarter of 2012-13 show that the current account deficit
continues to rise, and has touched a record 5.4 per cent of GDP. Both of
these developments that would be considered signs of “overheating”
occur at a time when growth is slowing.
However, the
high current account deficit to GDP ratio is not merely because the
denominator – GDP -- is lower than expected because of slower growth. It
also reflects certain structural problems characterising the
numerator-the current account deficit-which prevent its contraction when
the economy grows more slowly.
Consider figures for
the first half of this financial year relative to the corresponding
period of the previous year. As Chart 1 shows, the current account
deficit is higher this year when compared to the previous one partly
because the trade deficit has risen from $59.1 billion to $61.1 billion
despite slowing growth. This has meant that despite absolutely large net
capital inflows into the country, of as much as $40 billion over the
first six months of this fiscal, India is just able to finance its
current account deficit. The period when a large share of capital
inflows went to buttress India’s foreign exchange reserves seems to be
over. In fact, if inflows shrink or the deficit widens, the rupee would
be under much pressure.
This raises the question as
to why the trade deficit remains high. One reason, emphasised by the
government, is that exports, especially to Europe, have been adversely
affected by the global recession. As Chart 2 indicates, goods exports
over the first six months of this fiscal year have fallen with respect
to the last and the increase in services exports has been inadequate to
neutralise that fall. But this is not the only problem. While India’s
exports are sensitive to global income declines, India’s imports have
been less responsive to the slow down in income growth. It is well known
that two items of imports have played an important role in keeping
India’s import bill high-oil and gold. In the case of both these
commodities, prices have declined in international markets during the
period in question. However, in the case of oil the quantum of imports
has increased to push up the import bill. And in the case of gold,
though the decrease in the import bill is a noticeable 13.7 per cent,
high growth rates and levels in the past have ensured that the outgo on
this account has remained high.
In sum, the import
bills on account of both oil and gold do not seem to fall much despite
rising prices and slowing GDP growth. A feature of both these
commodities, especially gold, is that it is the rich that largely
account for the growth in their demand. Over the year ended September
2011, demand for gold in India was 1059 tonnes, as compared with 214
tonnes in the US and 770 tonnes in China, whereas per capita income in
the three countries stood at $1,410, $48,620, and $4,940 respectively.
The “average” Indian could not be responsible for such “excess demand”
for gold. It is the rich who are clearly responsible. The incomes of the
rich are not affected as much by the slow down. And, the demands of the
rich are relatively inelastic or non-responsive with respect to price
changes. This structural feature influencing India’s import bill is what
accounts for the asymmetry in the response of exports and imports to
world and domestic incomes respectively. What is needed is an effort at
curbing such elite consumption. While this may be difficult to implement
through physical controls in the case of oil, it can easily be done in
the case of gold.
With the government failing to do
so, the balance in the trade in goods and services has turned
increasingly negative. But that is not all. Corporate India, which has
been borrowing heavily from international markets to exploit the lower
interest rates prevailing there, has also begun tapping the nation’s
foreign exchange earnings to meet its foreign debt service commitments.
As the RBI’s Bulletin for March 2013 notes: “Net outflow on account of
primary income not only continued in Q2 of 2012-13 but also showed an
uptrend mainly on account of higher interest payments under external
commercial borrowings (ECBs) and FII investments in debt securities.” In
the event, despite increase remittance receipts from Indian workers
abroad (Chart 3), there has been a decline in net receipts from income
payments.
The consequence of all of this is a
worsening of the current account deficit, which the RBI sees as having
entered the danger zone. Addressing this requires reining in the import
bill, which in turn requires curbing elite consumption. India’s rich are
the real problem.
The Hindu
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