SEPTEMBER 18, 2018

By TIOL Edit Team

THE Government has done well in deciding to give calibrated response to external challenges faced by the economy.

The timely response is welcome as unmanaged current account deficit (CAD) can trigger full blown economic crisis - inflation, financial markets turmoil, rise in fiscal deficit and a big setback to inclusive growth.

As put by Reserve Bank of India (RBI) in its annual report for 2017-18, "CAD is widening as imports increasingly replace domestic production in several items, besides the elevation in international crude prices. In this context, aggregate demand pressures emanating from a deviation from the budgeted fiscal deficit of the general government may spill over into higher external imbalances, contributing to a 'twin deficit' challenge". The twin deficit obviously means CAD and fiscal deficit.

The first phase of calibrated response is five steps announced by Finance Minister Arun Jaitley on 14th September 2018 after a meeting chaired by Prime Minister. These are: 1) a review of the mandatory hedging conditions for external infrastructure loans; 2) permission for manufacturing companies to raise up to USD 50 million through such loans for a minimum period of a year as compared to 3 years at present;3)review the cap on the exposure of foreign portfolio investors in bonds of a business group (currently 20%) and 50% of a single bond issue; 4) Masala bonds will be exempted from withholding tax this financial year and Indian banks will be allowed to become market makers in masala bonds including by underwriting and 5) government will make efforts to reduce non-essential imports and increase exports.

The underlying objective of the initiatives is to expedite and enhance foreign exchange inflows & reining in outflows. This, in turn, would help check depreciation of Rupee and rise in CAD.

Mr. Jaitley stated that certain other market-sensitive issues were discussed. The Government would announce decisions on these issues and foreign trade policy in the coming weeks. We hope proposed import restrictions don't prompt exporting countries to lodge complaints with World Trade Organisation. Import restrictions should be planned without affecting domestic manufacture.

IMF has projected increase in India's CAD to 2.6% of GDP by assuming crude oil price at average USD 71.8/barrel in 2018-19. As mentioned in IMF's staff report on India released during August 2018, the Government admits that CAD above 3% of GDP "may pose financing difficulties".

There appears to be broad consensus among leading economic entities about India's projected CAD. The Organisation for Economic Cooperation and Development (OECD) has projected India's CAD to rise to 2.5 in 2018-19 and further to 2.7% in 2019-20.

In July this year, CRISIL projected CAD rising to 2.6% of GDP in current financial year due to widening merchandise trade deficit.

Another credit rating major has projected CAD at 2.8% in current fiscal year.

In its External Sector Outlook released a few day back, ICRA "expects the current account deficit to widen significantly to ~USD 72-77 billion (2.8% of GDP) in FY2019 from USD 48.7 billion in FY2018 (1.9% of GDP), unless commodity prices recede appreciably from the prevalent levels".

The actual GDP would, of course, depend on impact of several factors. These include unwinding of ultra-low interest rate regimes in the United States and certain other developed countries, US investment and taxation reforms and the brewing trade wars between the US and other countries.

Other major factors are: further increase in crude prices due to US sanctions against Iran, net foreign investment inflow or outflow from India, value of rupee and impact of unfolding calibrated response from Modi Government.

The calibrated response should, however, trigger wider debate on structural reforms. All claims of structural reforms made by different regimes since 1991 fall like house of cards when India is faced with external risks. The situation this time is no different.

As in earlier adverse external situations, the rising crude oil prices, depreciating rupee, widening trade deficit, declining net foreign direct investment (FDI) have all fueled rise CAD. India has been living with CAD for decades, with two or three year being exceptions when we had current account surplus. These were 1977-78 and 2001-02.

The dependence on foreign direct investment in equity and debt for financing CAD can't go on forever. Living on borrowed feathers (aliens' money) can prove dangerous in the long run. Exports and invisible receipts must finance CAD in minimal zone, if not turn into current account surplus.

The Government should thus undertake credible labour, environmental approval reforms and oil and gas reforms. All such structural reforms should collectively create a durable platform for increasing India's total factor productivity and generating massive export surpluses.

Government ought to take hard look at public interest litigation, leading to project delays, stoppages and closures. There is a trade-off between environmental activism and indigenous production and foreign trade. To what extent has this trade-off resulted in avoidable imports?

Can outright mining bans be avoided in the court verdicts against crooked businessmen and rulers? The Government and the judiciary must jointly discuss these issues.

A lot needs to be done to improve ease of doing business at the ground level and to impart business certainty, without which investment cycle will not pick up.

India must ensure at least sustained 10% GDP growth & 20 percent export growth year after year to improve ease of living for the country's restless population that is on its way to becoming the world's largest.