FIIs save the day, exports continue to worsen
At $10.1 billion, or 2.1% of GDP, the Q2FY15 current account deficit is certainly higher than the $7.9 billion (1.7% of GDP) it was in Q1FY15, and the worst since Q1FY14, but is well within comfort levels despite the Q2 surge in gold imports. For one, the oil prices collapsing after October will dampen the import bill further—POL imports in the first half of the year were $33.6 billion compared to $32.6 billion in the same period last year—and will more than make up for a surge in gold imports, were that to sustain in the second half of the year. What is a more serious concern, however, is the dramatic collapse in exports. After rising 10.6% in Q1FY15 over that a year ago, exports growth fell to a mere 5% in Q2. With India missing the bus on wheat exports thanks to bureaucratic lethargy—local prices are now higher than global ones—and global commodity prices crashing, agriculture exports are no longer the big growth item they were earlier; indeed, rice exports have contracted in comparison with last year; petroleum exports have been flat while pearls and semi-precious stones—India’s second-largest exports—contracted 14.6% in April-October; cotton readymade garments, India’s 6th largest export item, grew just 5.6% in April-October. Imports rose 8.1% in Q2FY15, after having contracted 6.5% in Q1, a sign of increasing local demand, though a large part was also the result of gold imports rising—without gold, Q2 imports rose 5%. While the focus remains on high gold imports—$18.8 billion in April-October 2014—it is worth keeping in mind that coal imports in the same period were over $10 billion while those of telephone instruments were a high $8.5 billion and other electronics imports were over $6 billion in the same period. Bulk mineral and ore imports, interestingly, rose 24% in April-October, to over $4 billion.
While the collapse in exports is connected with the sluggish economy in Europe and China, it also remains true that India’s currency is probably over-valued with respect to competitor countries. Large FII flows—$22.2 billion in the second half of FY15 as compared to an outflow of $6.8 billion in the same period last year—have helped keep the rupee strong during this period. All of which means RBI will have to continue to buy dollars; in any case, if RBI has to increase India’s foreign exchange reserves to 10 months of imports as compared to around 7-7.5 right now, it will need to increase reserves by another $100 billion over the next two years. That means RBI needs to mop up the entire surplus on the capital account—estimated at $40 billion for FY15 by Axis Bank, given the surge in FII flows in the first half of the year—for the next couple of years, and perhaps even more.