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Friday, 29 March 2013 00:00
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CAD starting to look unsustainable


Given the dramatic worsening of the trade deficit, to nearly $60 billion in Q3 as compared to $48 billion in Q2 and $42 billion in Q1, it’s not surprising Q3FY13’s current account deficit (CAD) is the highest independent India has ever seen at 6.7% of GDP. Though Q3FY13 exports fell 4% versus Q3FY12, they rose in absolute terms on a sequential basis—from $69.8 billion in Q2 to $71.8 billion in Q3. While exports remained largely flat in absolute terms sequentially, the festive surge in gold—Q3 imports of non-monetary gold rose $6.4 billion over Q2—ensured the trade balance worsened significantly. Services did moderately well, from a net of $15.2 billion in Q2 to $17.6 billion in Q3 despite software exports being largely flat—they rose 2.5% sequentially in dollar terms. But more than just oil and gold, other factors that hit the CAD were the dismal export performance, and rising coal imports—from under 0.5% of GDP in the pre-Lehman period, these are around 0.9% of GDP right now. Repatriation of profits, for instance, rose to around 1.3% of GDP, from $5.1 billion in Q1 to $5.9 billion in Q2 and $6.5 billion in Q3.

If the deterioration in the CAD wasn’t bad enough, financing has become an even greater nightmare with FDI flows collapsing by nearly a third. From $8.2 billion in Q1, gross FDI flows rose to $13.1 billion in Q2 and then collapsed to $9.1 billion in Q3. Outflows, or repatriation of profits, rose from $4.3 billion in Q1 to $6.6 billion in Q3. To compensate for the slowing FDI, loans rose dramatically, from $34.2 billion in Q2 to $40.7 billion in Q3 while NRI flows remained flat at around $15 billion. Higher financing of the CAD, which is also getting worse, puts the future at risk. Net repayments of loans and interest payments, for instance, were around $10.6 billion in Q3, or a little over 2% of GDP. So, all else being constant, India needs fresh loans of this amount just to get the same amount of net capital.

Which is why, as our lead column today argues, financing the deficit has become a matter of concern now. Though external debt to GDP has fallen from 27% in FY96 to around 21% right now, short-term debt to total debt has more than quadrupled to 23% of GDP—this is also the reason why, despite record FII flows, the rupee remains as weak as it does. The levels of what is a sustainable CAD, it is true, have gone up over the years—from a 1.6% of GDP estimate of the high level BoP committee in 1993 to around 3% by the fuller capital account convertibility committee in 2006—but a good way to look at this is to look at how India’s net external liabilities get impacted. Right now, at $282 billion, India’s net international investment position is around 14.8% of GDP—a persistent CAD of around 4% of GDP means India’s net external liabilities position can exceed 25% of GDP in another 3-4 years—that’s the level which most would consider completely unsustainable. Given the high fiscal deficit is ultimately the reason for the high CAD, fixing this remains the key.


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