India's Current Account Deficit: Where The Illness Becomes The Cure

With the rupee touching new lows against the dollar every day, a lot is been talked and written about. The rupee is currently trading at around Rs 66 per USD, sending jitters across the markets.

One of the prime reasons attributed to this dismal performance of the rupee is the ever-widening current account deficit (CAD). For FY13, India’s CAD stood at USD 87.9 billion or 4.8% of the GDP against USD 78 billion for FY12, which was 4.2% of the GDP. Gold imports are one of the key factors that led to deteriorating of the CAD. They have increased from USD 4.1 billion in FY01 to USD 53.7 billion in FY13, thus aggravating the deficit situation.

It is also accentuated by the slowing of the Indian economy and by the outflow of foreign funds from the Indian shore. Economic growth has almost halved from its peak, which was seen a couple of years ago. In the last two quarters, we have seen GDP growth drop below 5%. This trend may continue in this quarter too (Q1FY14), and we may see GDP growth below 5% for the third consecutive quarter (GDP numbers are expected to be released on August 30, 2013). Since May 22, the net FIIs outflow has crossed USD 15 billion, in both equity and debt markets.

Nonetheless, the factors that have led to the fall in the rupee are going to help stabilise the rupee going forward and will subsequently help the CAD to go below the FY13 level, both in absolute term as well as percentage of GDP.

Firstly, the action taken by the government to curb gold imports is yielding results and is visible from the data available for gold imports. Total gold imports have fallen from USD 14 billion for the month of April-May 2013 to USD 4 billion for the month of June-July 2013, although a part of this fall can be attributed to the fall in international prices of gold. The second factor that will help reduce the CAD is the slowdown in economic activity that will lead to lower demand for imported products. For the month of July 2013, imports fell by 6.2%. The recent outflow of foreign money from debt as well as equity markets will also help narrow down the CAD. Current outflows will subsequently lead to a decline in the future outflow of payments needed to service these investments, like interest and dividend payments.

The depreciating rupee will not only help us curtail our imports, but will also help us boost our exports. India’s merchandise exports grew 11.64% to USD 25.8 billion for the month of July 2013, thus vindicating this fact. The depreciated rupee will also help attract remittances, which were at USD 64 billion last fiscal and are likely to grow at around 10% this fiscal.

Hence, we believe we are going to see a positive surprise on the CAD front for the quarter and it may come down to below 4% for FY14. The only caveat to this is the sudden spike in crude oil prices. If crude oil prices remain under control and the government is able to raise diesel prices substantially now, as many of the oil marketing companies (OMCs) are demanding, we will definitely see a remarkable improvement in both, the CAD and the rupee, by the end of FY14.