Widening current account deficit to hurt macro economy

Strong macro-economic fundamentals notwithstanding, warning bells are loud and clear in India's external sector with current account deficit (CAD) inching towards 3% of GDP and trade deficit moving towards a record $200 billion this financial year.

Former RBI Governor Y V Reddy, who is known for his conservative approach, is right in saying that all is not well with India's widening current account deficit as it is more pronounced than what the figures point out. His argument is that India has a huge cushion by way of NRI remittances, which by itself account for 2% of GDP.

This means that a CAD of 2.5-3% of GDP is actually 4.5-5% of GDP, which does not augur well for the economy. Larger the CAD, the weaker would be the currency. The CAD in Turkey was as high as 5.5% of GDP and hence the depreciation of Turkish lira was most steep among the emerging countries.

The falling rupee too has been one of the worst performing currencies in the emerging market space. But the calibrated depreciation of rupee is aiding India's exports, which has now started looking up.

However, India would take a hit on its oil import bill, which is hurting the macro-economic stability. A weaker rupee will also deter Indian companies from borrowing overseas funds, thus putting brakes on the industrial recovery.

Opinion in government appears to be on how to deal with the situation. Finance minister Arun Jaitley asserted that "If we start sacrificing our macro-economic fundamentals in order to temporarily push up the growth, then we are hurting ourselves." This shows that he is for belt-tightening measures to rein-in the burgeoning CAD.

But Niti Aayog vice chairman Rajiv Kumar said that India is not in that kind of a crisis at the moment that would require hiking rates and cut expenditure and in turn curb economic activity.

But economic pundits argue that CAD beyond 2% is worrying and corrective measures are required to ensure that economic fundamentals remain strong.

Rating agency Icra's principal economist Aditi Nayar said, "CAD will increase to $67-72 billion or 2.5% of GDP in FY19, up from $48.7 billion or 1.9% of GDP in FY18. The annualised rise in CAD is likely to continue for the seventh consecutive quarter in Q1, driven by high commodity prices and demand for imports for machinery and electronic goods amid a contraction in exports of readymade garments, gems and jewellery and Iron ore."

Airing similar view point, Joy Rankothge, vice president - senior analyst, Moody's Investors Service, said while the weaker rupee will benefit exports at the margins, it is unlikely to reverse the trade deficit, which hit a five year high of $18.02 billion in July.

"India's current account deficit is likely to widen to 2.5% in FY19, up from 1.5% in fiscal 2017 due to higher oil prices and strong non-oil import demand as domestic demand accelerates. Net oil imports accounted for 2.6% of GDP in FY18 and will increase further in fiscal 2019," he said.

NIPFP economist N R Bhanumurthy, who authored the controversial back series GDP data, told DNA money that the rising CAD though a concern, does not require any knee-jerk reaction at this stage. "There is no need to panic now as even with 2.5% CAD, it is possible to achieve 8% growth. We will have to wait and watch how the quarterly GDP numbers pan out," he said.

The first quarter (Apr-Jun) GDP numbers will be announced later in the day today. It is for RBI to decide if it wants the growth momentum to continue keeping inflation at a slightly elevated level around 5.5% or sacrifice growth a bit to keep inflation within the targeted level of 4%. Indications are that there could be another hike in short-term repo rates in the next monetary policy middle of next month.

Crisil chief economist D K Joshi felt CAD is not that worrying at this stage. "It is manageable. Of course, the rupee has weakened, so also other currencies, as the dollar has been strengthening," he said.

One should also not forget that the rupee has been strengthening during the last four years and this required correction and so a fall in rupee has helped to some extent, he added

Icra said in its latest report that on a positive side, the weaker rupee has seen the services trade surplus rise at a healthy 9.7% in the first two months of this fiscal. It has also supported increased remittances from non-resident Indians.

Though opinions are divided, one thing is clear that surging current account deficit has the potential to fuel inflation, widen the fiscal deficit, slowdown growth and turn rupee volatile. A gradual fall in rupee, however, may help exports and to that extent narrow CAD as global oil prices are expected to stabilise at a slightly lower level.