India seen more vulnerable to external shocks as BoP worsens.

New Delhi: In an indication of growing pressure on the external sector, the Reserve Bank of India (RBI) disclosed that the current account deficit of the balance of payments (BoP) had risen to 4.3% of gross domestic product (GDP) at the end of the third quarter ended December—compared with 2.3% in the same period in the previous fiscal.

For the first time since 2008-09, capital inflows were unable to finance the current account deficit, forcing a drawdown of foreign exchange reserves by nearly $13 billion (Rs66,560 crore today).

What is worrying economists is that this is happening simultaneously with a deterioration in the fiscal deficit, or gross borrowings of the Union government, particularly since the onset of the twin-deficit syndrome—the fiscal and the current account deficit—had preceded the economic crisis in 1991.

To be sure, India is not facing a similar threat at this point of time, but it leaves the economy particularly vulnerable to external shocks such as a sudden spurt in international oil prices.

The fiscal deficit projections of the government for 2011-12 have gone awry, with the government revising it upwards to 5.9% of GDP from 4.6% projected earlier. The actual fiscal deficit, experts fear, may be worse than projected in the revised estimates. According to data released by the Controller General of Accounts, India’s fiscal deficit in April-February was at Rs4.94 trillion, around 95% of the revised full-year target of Rs5.22 trillion.

The current account deficit is the aggregation of the trade deficit and net invisibles (such as software export receipts and repatriations). Put another way, it reflects that part of the consumption generated by the economy which is met through external resources.

“India has a twin-deficit problem. It is not a good thing to have given that the global environment is still fragile. It makes the Indian economy more vulnerable,” said D.K. Joshi, chief economist at rating agency Crisil Ltd. “If crude prices increase sharply, it will exert pressure on both the fiscal and current account deficit. Besides this, the global crisis could see capital flows drying up.”

India’s current account deficit increased to $19.6 billion in October-December from $10.1 billion a year ago, mainly on account of a rising trade deficit. A rising import bill consisting mainly of petroleum products and gold, coupled with a slowdown in exports, widened the country’s trade deficit to $47.7 billion in the December quarter from $31.4 billion in the year-ago period.

After fuel, gold is the most imported commodity, contributing along with silver more than 13% to India’s imports in the first half of the current fiscal—gold and silver imports rose by little over 70% in the first half of the year. While merchandise exports grew by only 8% to $71.2 billion, growth in merchandise imports was much more robust at 22% to $120.5 billion in the quarter.

“In the third quarter, what has happened is that GDP growth has slowed, but current account deficit has increased. So a current account deficit above 4% was expected,” Joshi said.

Net capital inflows were lower at $8.2 billion in the quarter, down from $14 billion, primarily due to a sharp fall in portfolio inflows and increase in repayments of overseas borrowings.

Net portfolio investments in the quarter fell sharply to $1.8 billion from $6.1 billion.

“Going ahead, servicing foreign loans and short-term debt will exert pressure on BoP,” he said.

The drawdown from the foreign exchange reserves was $12.8 billion as compared with an accretion of $4 billion in the December quarter in the previous year. India’s total foreign exchange reserves are around $295 billion.

In the review of the Indian economy released last month, the Prime Minister’s economic advisory council had projected that current account deficit for 2011-12 will be around $66.8 billion, or 3.6% of GDP.

But in the fourth quarter, the council hopes that higher net invisible inflows will improve the current account position. “This, coupled with stronger capital inflows, has and will continue to relieve the pressure on BoP that came into sharp focus in the third quarter,” it said.

Samiran Chakraborty, head of India research at Standard Chartered Bank, said that the problem of fiscal and current account deficits, coupled with inflationary pressures, may affect capital flows into the country from the next fiscal year and make India more vulnerable to external shocks.

“In the fourth quarter, India saw good capital inflows because investors expected that RBI will start cutting rates. But given the fiscal deficit projections, there is an expectation that the pace of rate cuts will be slower,” he said.

In the quarter, India’s external debt position also worsened on account of higher commercial borrowings and short-term trade credit. The external debt stock was $334.95 billion (20% of GDP) as of December-end, compared with $323.93 billion (17.8% of GDP) as of September-end, according to data released by the finance ministry.

India’s foreign exchange reserves provided a cover of 88.6% to the total external debt stock at end-December 2011, compared with 96.2% at end-September.

Source : livemint.com