Why this kolaveri over current account deficit
Current account has conspicuously emerged as one of the primary
concerns in past couple of months. Everyone – Government, RBI, investors,
analysts, economists and financial institutions – seems extremely concerned
about the current account deficit. The other deficits – fiscal, governance,
trust, energy, infrastructure et. al. have taken a back seat for the time
being.
In our view, the concern over high current account deficit,
though not completely unwarranted, may be slightly misplaced. We worry that
more than due emphasis on the problem may lead to desperate solutions leading
to introduction of some structural imbalances in the economy, e.g., RBI
postponing the replenishing of forex reserves, unwillingly liberalizing FII
debt investment rules, enhancing export subsidies, etc.
Following the oil price shocks in the 1970s, there have been
large swings in the current account balances of most countries. Australia, New
Zealand, Portugal and the US have been running large current account deficits
for the most part of the 1990s. At the end of 2000, the US current account
deficit had reached to $415.5 billion, equivalent to 4.5 percent of US GDP.
There is enough empirical evidence to suggest that while some countries such as
Ireland, Australia, Israel, Malaysia and South Korea were able to sustain large
current account deficits for many years, other countries such as Chile and
Mexico suffered severe losses. Excessive current account deficits in crisis
countries were also a prevalent feature of the 1997 Asian crisis.
Current account measures trade, international income, direct
transfers of capital, and investment income made on assets. A current account
deficit is when a country's government, businesses and individuals import more
goods, services and capital than hey export.
The current account by definition should correct itself in due
course. For example - the fall in currency value, a natural outcome of high
CAD, should normally result in rise in the value of foreign and gold reserves
of the country; it should make the exports competitive and destroy the demand
for inflated imports if CAD persists for longer period; the high yield on
currency should attract more capital resulting in higher investment, employment
and savings rate resulting in creation of additional local capacities leading
to import substitution.
However, artificial curbs like capital controls, managing the
currency value at artificially higher level, and forced import substitution and
subsidization, may introduce structural imbalances in the economy that may take
longer to correct.
Given that the Indian currency is mostly convertible on trade
account now (this was not the case during Asian crisis of 1990s) we need to be
little more cautious. But interfering with market forces will only exacerbate
the problem.
We continue to suggest a short trade on INR, with the
expectation of a 7-10% fall in next 6-9 months.
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