Widening current account deficit a new worry for Modi government, RBI | columns | Hindustan Times–17.09.2017

In April, a top commerce ministry official told a group of financial journalists “not to be alarmist” over rising gold imports. The reporters wanted to know if the government was planning any action in the wake of a sudden and sharp spike in gold imports in the preceding month. The official assured them that the government was keeping a watch and would take action, if needed, at an “appropriate time.” Looking back, it appears the authorities may not have been as alert as they ought to have been, or that they erred in reading the situation.

Data released by the Reserve Bank of India (RBI) on Friday showed India’s current account deficit (CAD) rose sharply to a four-year high of $14.3 billion, or 2.4% of GDP, in the April-June quarter. It was $3.4billion, or 0.6% of GDP, in the preceding quarter. Current account deficit is the difference between the value of goods and services a country exports and imports. A higher CAD is not necessarily bad if the bulk of it is on account of such imports that help exports and growth and is financed through higher inflow of foreign direct investment. Historically, in the Indian context, a CAD below 3% of GDP is considered sustainable. On the face of it, therefore, a CAD of 2.4% in April-June may not appear worrisome. But a closer scrutiny of why and how the deficit widened so fast will call for remedial measures that must be taken without losing time.

The CAD has widened because imports have grown much faster than exports. Imports have risen faster because of a surge in gold imports and, to some extent, a higher cost of crude oil in the global markets.

India is the world’s second largest gold consumer, where demand for the yellow metal usually peaks in the second-half of the year especially during the festive season of Diwali and Dussehra. But according to the World Gold Council, demand for gold in the first-half rose 30% from a year ago to 298 tonnes. Imports grew even faster and more than doubled to 518.6 tonnes. This is puzzling and begs investigation.

Worse, gold imports continued to surge through July and August, thanks to a loophole in the newly introduced goods and services tax (GST). The government charges a 10% import duty on gold, but this does not apply to countries with which it has Free Trade Agreements (FTAs), such as South Korea. However, to prevent duty-free imports from those countries, it had previously levied a 12.5% countervailing duty, which got inadvertently scrapped when GST was introduced on July 1. Gold importers took advantage of this and placed huge orders with exporters in South Korea without paying any tax.

The government stopped this on August 25, but gold imports for the month had already jumped three-fold, the impact of which will show when data on CAD for the July-September period becomes available. As petroleum minister Dharmendra Pradhan indicated last week, India’s crude oil import cost could rise more than 10% through this quarter. That will add to the deficit, given that exports have not yet gained momentum.

A slowing economy and a growing CAD make a lethal combination. While the former would tend to discourage foreign capital inflows, the latter would have a cascading impact on inflation and competitiveness of Indian exports. Ignoring these warnings could lead to a repeat of what the economy witnessed in the terminal years of the UPA government, when the CAD peaked to an all-time high of 4.5% of GDP, precipitating a crisis for the broader economy.

The imperative in the immediate term would be to identify all such imports that do not aid growth or investment and bring measures to curb them – gold, obviously, should top that list. In the short to medium term, however, the focus must be on exports – identifying sectoral issues and bottlenecks and addressing them on a war footing. On the brighter side, India’s high level of foreign exchange reserves offer enough cushion to maintain orderly conditions in currency trading even if the current account deficit gets out of hand for a couple quarters. But that should not make the government and the RBI complacent.

Rajesh Mahapatra is the chief content officer, Hindustan Times.

Follow the author at @rajeshmahapatra

via Widening current account deficit a new worry for Modi government, RBI | columns | Hindustan Times

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