Finance Minister Palaniappan Chidambaram has been touring the globe for the past few months. In January, he was in Hong Kong, Singapore, London and Frankfurt. He visited Dubai at the end of March and headed for Japan in early April. His agenda everywhere was to reinforce India's commitment to reforms and attract investment. The urgency in trying to woo foreign investors is understandable given the widening current-account deficit
(CAD), the broadest measure of trade.The CAD and the fiscal deficit
, together called the twin deficits, are among the government's main worries. While the government has managed to rein in the fiscal deficit, the CAD is ballooning. The gap touched a record 6.7 per cent of gross domestic product in the third quarter ended December 2012.
This is against 5.4 per cent in the previous three months and far higher than the Reserve Bank of India's (RBI) comfort level of 2.5 per cent. For the nine months through December, the deficit is at 5.4 per cent compared with 4.1 per cent a year earlier. In absolute terms, the gap rose to $71.7 billion for the nine-month period from $54.6 billion.
"A high CAD makes us vulnerable as the external environment becomes uncertain," says D.K. Joshi, Chief Economist at ratings firm CRISIL. "We need strong capital inflow to fund this deficit and in today's environment it is risky. We need to correct the problem."
Why is the widening gap a cause for concern
? A sustained high CAD will hurt the rupee. A weak rupee will make imports costlier, further exacerbating the CAD. The high deficit will also hamper the RBI's ability to lower interest rates. The main reason for the widening CAD is the growing trade deficit, fuelled by a surge in oil and gold imports.
The two commodities account for nearly 40 per cent of the country's import bill. Precious little can be done to rein in crude oil imports. But many say that gold, seen as a hedge against high inflation, is an unproductive expense. "We import 40 per cent of global gold production. We do not need that much gold," says M.R. Sivaraman, a former revenue secretary, suggesting gold imports be banned for six months. In a recent Google Hangout chat, Chidambaram said the CAD would shrink by half if India stopped importing gold for a year. In Japan, he said the government and RBI were working on inflation-indexed financial instruments to reduce the clamour for gold.
So far, the government has been able to finance the deficit with the help of foreign capital flows. This is again a matter of concern because this capital is coming mainly as portfolio investment, which is volatile, and not as the more stable foreign direct investment (FDI). According to RBI data, FDI in the nine months through December fell to $15.3 billion from $20.7 billion a year earlier. Portfolio investment surged to $14.6 billion from $3.2 billion during the same period.
Experts say the government should take measures to boost exports as well as raise fuel prices and open up mining of coal and iron ore to attract foreign investment and control the deficit. "Only strong measures will restore confidence in India among foreign investors," says Sivaraman.