The Reserve Bank of India (RBI) released data on India’s balance of payments during the second quarter of 2012-13 on Monday that made for sobering reading of challenges as India heads into the new calendar year. The challenges ahead are severe. The headline number: 5.4 per cent. That’s the percentage of gross domestic product (GDP) represented by India’s current account deficit in the quarter between July and September of 2012. For the corresponding quarter in the previous year, the current account deficit had been 4.2 per cent of GDP — high enough, true, but not as obviously alarming as the number for the second quarter of 2012-13. The sharp widening in India’s current account deficit came from the fact that India’s export revenues continued to fall sharply, and imports simply could not decline enough to compensate. A large proportion of that stickiness in imports was due to demand for gold, which stayed high through 2012, reflecting the failure of India’s financial sector to offer products that entice investors away from the oldest store of value of all.
The current account deficit is being financed by high capital inflows. The last year was a record one for the Indian stock markets thanks to extremely high interest in Indian shares from foreign institutional investors. Thanks to the FIIs’ fund flows into India, the current account deficit could be managed — but it should be evident how fragile an external account security can be if it is built on the goodwill of FIIs alone. On Monday, too, the finance ministry released information on India’s external debt position at the end of September 2012, which corresponds to the second quarter of 2012-13. It had gone up by 5.8 per cent over the quarter; of that, short-term borrowings had risen most sharply, at 8.1 per cent more than they were in end-March 2012. No country can survive for long by financing its imports through short-term debt before a crisis hits it.
What are the signals for the future in these data releases? The biggest point is that demand in India is still, perhaps, too high for fundamentals to finance. In particular, demand for gold and oil is too high for India’s exports to buy. If the world economy recovers, then India’s exports might see an uptick — but this will be a slow process. In the meantime, other mainstays of external financing are weak. The RBI has specifically pointed out that growth in private transfers has been very weak. Remittances grew only 2.9 per cent in the second quarter of 2012-13 — compare that to the growth in remittances in the same quarter of the previous year, when they grew in excess of 20 per cent. Poor export performances have been bailed out by strong remittance growth in the past — that saved the figures for 2011-12 from being too shocking. This year, India is not having that comfort zone. It cannot continue financing this through building up non-resident Indian deposits or high external commercial borrowing by firms, or foreign institutional flows. Equity flows financed more than two-thirds of the current account deficit in July-September 2012, as opposed to under 30 per cent in July-September 2011. At any moment, equity investors could turn back on India. Remittances are likely to stay weak. Exports cannot improve overnight. Suddenly, India may be unable to afford oil or gold — a textbook crisis. The figures released on December 31, 2012, show how close India is to one. It will be policy makers’ prime task in 2013 to avoid it.