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Saturday, 31 March 2012 07:57
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Worst CAD since 1991, fiscal deficit to rise further

At 4.3% of GDP for the third quarter of the current year, India’s never had a higher current account deficit in the last 40 years at least and, going by the fiscal deficit numbers also put out on Friday, the fiscal deficit is likely to overshoot even the budget’s 5.9% estimate (as compared to the 4.6% projected for FY12) unless revenues grow a massive 23% in March. While the trade account has worsened in January and February, gold imports have levelled off a bit, so Q4 current account deficit will be lower than Q3’s, and the year could end with a current account deficit of a little over 4% compared to the 3.6% the finance minister announced in the budget; with a fiscal deficit that’s around 6.1% of GDP, in many ways this takes India back to where it was in the pre-1991 crisis.

While India’s current account deficit has generally been financed through an increase in capital receipts (FDI/FII), this didn’t happen in Q3 FY12 and RBI had to draw down $12.8bn of its reserves to meet the gap. The last time this happened was in Q3 FY09 when the Lehman crisis struck. This is also the worst fall in India’s external balances. From FY78, when the current account was a surplus of 1.1% of GDP to the current account deficit of 3% of GDP in FY91, we had a deterioration of 4.1 percentage points; from the surplus of 2.3% of GDP in FY04 to a likely current account deficit of 4% for FY12, that’s a deterioration of 6.3 percentage points. While this means renewed pressure on the rupee, the worsening trajectory of the fall should make RBI wary of any more interventions to support the rupee—it used up $20bn to defend the rupee over the past few months.

More worrying in terms of overall balance of payments management is not just the current account deficit, but the overall investment climate. Portfolio investment in India fell to just $2.7bn in April-December 2011 as compared to $28.3bn in April-December 2010, but FII inflows rose to $9.1bn between January and now. But with the budget now talking of taxing FII inflows, these could well flow out again—while the finance minister has said investments through P-Notes will not be taxed, he has not given any such assurance about FII investments. And that’s assuming investors take such assurances seriously, given the retroactive tax amendments. With Vodafone now indicating it might take legal action in international arbitration courts, it joins a long list of companies contemplating the same—Telenor, MTS and investment firm TCI. The BoP scare, if nothing else, should prompt the finance minister to roll back some of his draconian tax proposals when he replies to the finance bill in May.



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