Given the dire state of India’s current account deficit (CAD) just about a year ago, the latest figures are comforting. From 5 per cent of the GDP in the second quarter of last fiscal — it went on to touch a historically high level of 6.7 per cent in the third quarter — it has now plunged to 1.2 per cent of GDP in the 2013-14 July-September quarter. This is well below the 2.5 to 3 per cent CAD posited as sustainable by Finance Minister P Chidambaram and various analysts. The change seems to be based on two factors: recent curbs on gold imports resulting in a decline in the high levels that had contributed to the large CAD last year, and a bump in exports caused in part by the rupee depreciation. This is good news in the short to medium term, of course — but it would be a mistake to take it as an all-clear. Several of the fundamental issues underlying the CAD are still very much in play and liable to crop up again the next time global headwinds pick up.
Breaking down the CAD is a useful exercise. Starting June 2009, trade in services has consistently delivered a surplus. The deficit, therefore, comes from the trade in goods. As far as imports go, for all of India’s slowing rate of growth, it is still in relatively better health than a great many economies given the continuing EU slump. Given that, high imports are unavoidable, even a signifier of economic health. But as former RBI governor D Subbarao pointed out, the quality of imports is important. An increase in the import of capital goods signifies a rise in industrial capacities and economic activity, and thereby, strengthening fundamentals. This, however, doesn’t seem to be the case in India.
To be certain, HSBC India has said that companies have raised their production levels for the first time in seven months, led by a rise in domestic demand. But the report also cites evidence of capacity constraint based on infrastructure weaknesses. The other factor to bear in mind here is that two sets of commodities — gold and petroleum and petroleum products — are responsible for a large portion of India’s import bill. The government may have clamped down on gold, but doing so for petroleum is not possible.
These two factors will not go away in a hurry; the CAD pendulum may well swing back in the other direction a year down the line. Deeper reforms are needed, starting with bolstering basic infrastructure, from transport to power. Removing supply side bottlenecks and clearing projects must get priority. This will serve not only to boost exports and allow domestic manufacturers to compete better with imported goods, but improve investor sentiment as well. Without it, attracting and retaining investment that, as matters stand, has plenty of reason to seek safer returns elsewhere, becomes an exceedingly difficult task. And improving domestic energy production is just as essential. Given India’s vast coal reserves, there is simply no reason that coal imports rose fourfold to $15 billion in the past six years, for instance. Exploration and allocation policies have run into numerous issues so far when it comes to the execution stage. Without addressing these basic issues, the current CAD cheer may prove to be all too brief.