Vijay Kumar Gaba: Keep it simple – Current account deficit

Monday, June 17, 2013

Keep it simple – Current account deficit

Our policy makers, regulators, economic commentators and analysts have all expressed their grave concerns over the swelling current account deficit (CAD) of India. However, we have not seen any concrete steps to address the roots of the problem. Most of the efforts seem to be focused on containing the legal import of gold and attracting more foreign debt so that at least balance of payment could be maintained. Last week the finance minister suggested that if Indians could restrain themselves from buying gold for one year, current account situation will improve dramatically.

Current account measures trade, international income, direct transfers of capital, and investment income made on assets. A current account deficit occurs when a country's government, businesses and individuals import more goods, services and capital than they export.

Theoretically, CAD arising from trade deficit is never a risk in itself. The excess of imports over exports essentially means that our economy is doing better than the other economies who import from us.

However, it could pose a serious risk if it becomes structural and persists for a long period, especially for a deficit emerging market like India. Consider the following:

(a) Substantial rise in social sector spending over past decade has led to unprecedented rise in consumption demand from lower socio-economic strata. Domestic supply has however not been able match the demand. Burgeoning middle class has been demanding more phones, computers, luxury automobiles, textile, food etc. not produced locally, besides leisure foreign travel. Young demography and rising aspirations have led to ever rising demand for global education and training as we have failed in constructing enough global standard institutions. These trends are not likely to change substantially even if our economic growth persists at current low levels.

(b) The structure of our exports has changed in past decade in favor of engineering products and services from predominantly consumer goods earlier; meaning our exports are now highly correlated to global growth, which is not likely to improve in near future.

(c) This structural weakness in trade composition necessitates higher capital inflows so that at least balance of payment could be maintained; meaning we have to maintain our interest rates at relatively elevated level so as to attract higher foreign capital; meaning domestic investment will continue to suffer and supply constraints will persist for longer period.

Only serious structural reforms that attract significant foreign equity capital and other resources to augment domestic supply could resolve this conundrum. The current political structure does not seem to be conducive for such reforms.

Insofar as gold is concerned – the government and RBI need to evaluate, is buying gold worse than splurging on fashion textiles brands, accessories, perfumes, luxury cars and boats, studying in third grade central European universities and holidaying abroad twice a year?