Current Account Deficit in India: Trends and Remedies


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As per the data in 2012, this presentation discusses trends in the current account deficit of India and remedies to it.

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Current Account Deficit in India: Trends and Remedies

  1. 1. By: Sumanth Patlolla (50A) Sanjeev Kumar (42A) Pratik Godhane (35A) Nikhil Indla (29A) Gukan K (18A) Anand Savur (8A) ----------------------------------- Vidooshi Joshi (55A) Sachin Gupta (38A) Manasi Jain (23A) Devansh Doshi (16A) Aniruddh Srivastava (9A) Abhay Sharma (1A)
  2. 2. Agenda AboutCAD Definition History Past trends Factors High imports Weak exports Twin deficit Growth and GDP Implications Depletion of forex Rupee Depreciation Weakening Investment sentiment Inflation Monetary policy Measures& Results Suggested Remedies
  4. 4. Definition Current Account – sum of ◦ Balance of Trade - export minus import of goods and services ◦ net factor income such as interest and dividends ◦ net transfer payments such as foreign aid. Current Account Deficit ◦ Associated with trade deficit of a country (Imports > Exports) ◦ Represents a net negative sales abroad ◦ For developing economies, transfer payments are important in terms of ◦ Donations, Workers’ remittances, Grants and aids, Official Assistance
  5. 5. History of CAD in India 1991 crisis is remembered as the BOP crisis but it was essentially a Twin Deficit problem India was unable to finance its CAD through capital inflows being a closed economy Symptoms & challenges – ◦ A CAD larger than the debt inflows ◦ Import cover nose dived to a mere 2 weeks in 1990-91 ◦ Fiscal deficit was at a high of close to 9 percent with persistently high revenue deficits ◦ Inadequacy of external funds to boost investment at a time when the government deficit had “crowded out” ◦ The production sector unable to help in reducing the deficits. The twin deficits created a much bigger BOP issue which forced India to take assistance from IMF and Bank of England.
  6. 6. Past trends The sharp decline in CAD in the past years is alarming because of – • instability of Foreign Institutional Investment • slowing down of FDI • threat of recessionary trends in the developed economies Source: Voice of Research; Paper by Sachin N. Mehta
  7. 7. Past Trends Average (1949 – 2013) : - 1.62 USD bn All-time high (March 2004) : 7.36 USD bn All time low (December 2012) : - 31.86 USD bn Source: 1991 -92 1992 -93 1993 -94 1994 -95 1995 -96 1996 -97 1997 -98 1998 -99 1999 -00 2001 -02 2002 -03 2003 -04 2004 -05 2005 -06 2006 -07 2007 -08 2008 -09 2009 -10 2010 -11 2011 -12 2012 -13 Current Account -22. -128 -36. -106 -196 -163 -209 -168 -203 164. 306. 639. -122 -437 -444 -635 -127 -179 -219 -376 -479 -6000 -5000 -4000 -3000 -2000 -1000 0 1000 AxisTitle Current Account
  9. 9. High imports – Crude oil Oil imports leapt by 40% in 2011-12 due to ◦ Weak rupee ◦ High rates of crude oil in Int’l Markets ◦ High demand in domestic markets Oil imports constitute a third of India’s imports and half of its CAD Source: Ministry of Petroleum & Natural Gas
  10. 10. High Imports - Gold Constant rise in – ◦ Value of gold imports ◦ Share of gold imports ◦ Amount of gold imports This was because, people started investing in physical assets such as gold and real estates to hedge their risk against price rise
  11. 11. High Imports
  12. 12. Weak exports Global economic slump and general deceleration in world trade saw a drop in exports of India in 2008-09 Iron Ore – ◦ India exported 117 mt in 2009-10 but only 18 mt in 2012-13. 2013- 14 is likely to see India becoming a net importer of Iron ore ◦ Shift from third largest exporter to importer mainly due to ◦ Cap in production in Karnataka ◦ Ban in Goa ◦ Strict environment regulation in Orissa due to SC rulings and State interventions Invisibles, or services which dampened CAD until recently have also lowered Rise due to recession in developed countries leading to fall in rupee
  13. 13. Twin deficit High CAD and Fiscal Deficit worsen each other Can be proved by – ◦ Mundell-Flemming Model ◦ High Govt. spending = Upward pressure on Interest rates ◦ More inflow of foreign capital ◦ Currency appreciation ◦ Fall in Net Exports = Trade Deficit ◦ Keynesian Theory ◦ X-M = (S-I) + (T-G) Fiscal deficitTrade deficit
  14. 14. Growth & GDP Indian CAD is counter-cyclical i.e. it rises when output falls and not when demand rises Due to low growth, imports have risen mainly to meet domestic demand instead of supporting economic growth This has put the economy on dangerous footing
  16. 16. Depletion of Forex Reserves Deficit on current account means net outflow of foreign capital i.e. $ outflow in India’s case Without equal or more amount of inflow, a deficit puts strain on a country’s foreign exchange reserves Which is why, India is so keen on FDI as it needs the foreign inflows to keep it’s current account deficit in check Due to existence of CAD, rupee has depreciated as a result of inflows being lesser than outflow of foreign capital Source: RBI
  17. 17. Depreciation of Rupee First and foremost implication, as we have been observing in the past couple of years is the depreciation of rupee which, in turn, results in a number of consequences as listed in the adjoining diagram – resulting in a viscous internal cycle. While depreciation boosts exports, the effects are quite delayed and uncertain.
  18. 18. Currency fluctuations Source:
  19. 19. Weak Investment Sentiment 2013 saw a capital flight out of India, especially in 2Q of 2013-14 This was due to weakening rupee It is important to maintain this inflow as it is currently responsible for maintaining the current account balance A high CAD has also led to decline in India’s credit rating, directly affecting investment 0.00 500.00 1000.00 1500.00 2000.00 2500.00 3000.00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 Total Foreign Direct Investment in India Source: RBI
  20. 20. Inflation A simultaneous and add-on affect of high fiscal deficit on CAD and a weakening rupee Inflation caused a steep decline in household savings in 2008-09 – and a rise in savings of physical assets, thus reducing the liquidity in the market This, in turn, resulted in greater demand for gold – raising its imports and fuelling an already soaring CAD
  21. 21. Impact on Interest Rates India has one of the highest interest rates in the world Interest rates have been raised since 2010 in order to curb inflation Hence, it is an indirect implication of a high CAD Growth has been sacrificed in the process
  22. 22. Measures taken HOW GOI MANAGED TO BRING DOWN CAD
  23. 23. Measures & Results Measures – ◦ Govt. increased taxes on gold in the world’s biggest user of the metal 3 times to balance the trade level which weighed down rupee ◦ Steep fall in rupee boosted exports ◦ Merchandise exports picked up ◦ Concessional dollar swaps for lenders to spur inflows in order to support rupee after the steep fall in August Results – ◦ CAD has reduced significantly and is more manageable now ◦ Hence, movement of Rupee is no longer about CAD but capital inflows – dependent on the behavior of global markets
  24. 24. Results quantified Source: RBI
  25. 25. Suggestions & Remedies WHAT ELSE CAN BE DONE?
  26. 26. -6 -5 -4 -3 -2 -1 0 1 2 3 0 100000 200000 300000 400000 500000 600000 700000 800000 900000 1000000 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 petroleum import CAD Address the Petroleum Issue 80% oil Imported Net Oil Import : $109 billion Trade deficit $196 Billion CAD: $88 Bn, 4.8% of GDP Increase Energy efficiency levels: Case In Point JAPAN Share of Oil has decreased from 77.4 % in 1973 to about 45% now Deregulation of oil prices: Slowly remove the subsidy 51% 14% 13% 18% 4% Transport Industry Commercial Domestic Agriculture $12 Bn Subsidy 2012 Govt. has started steps Innovation & conservation
  27. 27. Address the Petroleum Issue Put more tax on excessive use of oil: Bring in Incremental Pricing More incentives for growth of renewable sources of energy: a level playing field Reduce incentives/increase taxes for the transportation industry: Innovation Alternative sources in Shale gas and oil, Bio fuels, Bio Gas 32% 68% Shale Oil & Gas Non-Shale coal 42% oil 29% natural gas 9% hydro power 3% nuclear power 2% other 15% coal oil natural gas hydro power nuclear power wind power other Bio Fuel Programme Pricing of Ethanol Bio Diesel Shale Gas: Assam, Arunachal Pradesh, Nagaland And Manipur
  28. 28. Reduce Gold Demand 0 100 200 300 400 500 600 700 800 0 50 100 150 200 250 Jan 21: Import raised from 4% to 6% Jun 5: Import raised from 6% to 8% Aug 13: Import raised from 8% to 10% About 400 tonnes of recycled gold to enter the market this fiscal year to March 2015, compared with normal rates of about 130 tonnes, according to Thomson Reuters GFMS data Review gold/gold doré import on a quarterly basis to set the agenda Promoting national savings to fund investment. Schemes like the Rajiv Gandhi Equity Savings Scheme (RGESS) and the recently implemented Inflation Indexed Bonds (IIBs) to wean away investors from gold Allocate quarter import quota to agencies and let them bid for the gold on quarterly basis . 0 5000 10000 15000 20000 25000 0 5000 10000 15000 20000 25000 30000 sensex gold
  29. 29. Export Diversification Economic Risks Short term: Volatility and instability in foreign exchange markets Long term: Unpredictable declining terms of trade trends Political Risks: Poor governance, risk of civil war • Reduce dependence on a few geographical entities • Expanding opportunities for export and improvement of backward and forward linkages to domestic inputs and services West Asia- GCC 16.9952 North Africa 1.8914 EU Countries 16.7848 Southern African Customs Union (SACU) 1.7579 North America 13.2556 Other European Countries 1.3988 NE Asia 13.1117 Other CIS Countries 1.0424 ASEAN 10.9881 East Asia (Oceania) 0.9097 South Asia 5.0302 Other South African Countries 0.6279 Latin America 4.5 European Free Trade Association (EFTA) 0.4587 Other West Asia 3.7803 Central Africa 0.3099 East Africa 2.9425 CARs Countries 0.1835 West Africa 2.1716 Total 100
  30. 30. 0 20 40 60 80 India China Philippines Mexico Nigeria Egypt Banglade… Pakistan Vietnam Ukraine Remittances ($ billion) Remittance is the act of transmitting money to a distant location to fulfill an obligation. International remittances are transfers of funds by foreign workers—remitters—who are living and working in other countries typically to their families who are still living in their home countries • From a BOP perspective, remittances are permanent foreign currency inflows and help finance the current account, unlike NRI deposits which are repatriable • Part of these inflows get invested in stocks, bonds, fixed deposits and real estate • India received an estimated $71 billion (around Rs.4.4 trillion) in remittances last year (up from $69 billion in 2012) and much higher than China’s $60 billion • In India, remittances are larger than the earnings from IT exports and just under three times of the FDI received in 2013 • Weakening of the Indian rupee is usually followed by a surge in remittances since NRIs are expected to take advantage of the cheaper goods, services and assets back home Sources: Reserve Bank of India, IMF Balance of Payments and Bank staff estimates Foreign Remittances
  31. 31. Attract FDI FDI inflows are long term investments by overseas company setting up manufacturing and other commercial enterprises in India and hence represent more stable and dependable form a finance • Match FDI policy with Import duties, in such a way that rise in import duties acts as incentives to foreign direct investment in that particular sector • India also needs to focus on long-term foreign direct investment, which is sticky FDI inflows into India contracted by 38 per cent to $22.42 billion in 2012- 13 compared with $35.12 billion of FDI inflows the country witnessed in 2012 Source: DIPP
  32. 32. Factors holding back FDI investment in India Tepid economic growth Lack of transparency Lack of consistency in FDI policies Regulatory hurdles Infrastructure Deficiencies Foreign investment into India falls under one of two FDI routes: Government Route: For investment in business sectors requiring prior approval from the Foreign Investment Promotion Board (FIPB). Automatic Route: For investment in business sectors that do not require prior approval from the government, but the filing of a notification after the incorporation of the company and issue of initial shares. Government efforts to increase FDI include: 1) SEZs/EHTP/STP/BTP/NIMZ’z etc 2) Raising FDI cap in sectors like multi brand retail 3) Increasingly shifting the approvals under automatic route Solutions Open up new sectors like insurance and pension funds Ease regulatory hurdles through administrative reforms
  33. 33. Significant investor segment of the Indian capital markets, accounting for on an average 20% of the turnover in both the Indian equity and debt markets Increasingly been bridging the funding gap on the country's current account deficit. Also widely accredited for the high-speed growth in the Indian capital markets i.e. the equity market segment RBI’s enhancement on the limit of investment in government securities (G-Secs) by foreign institutional investors (FIIs) and long- term investors by $5 bn to $25 bn from $20 bn RBI’s change in rules to make it easier for foreign and NRI promoters to raise stake in listed Indian companies SEBI’s permission for FIIs to buy government bonds without purchase permits from it until overall investment reaches 90% Attract FII
  34. 34. At a time of 'global risk aversion', when investors are fleeing to safe havens, it becomes difficult to attract equity flows to a country like India, especially one with a weak currency, shaky current account, and uncertain macroeconomic outlook. Attracting investment through the ECB route becomes an instrument of choice. -8 -6 -4 -2 0 2 4 6 Recovery EU GDP% US GDP% The US Federal Reserve Chairperson Janet Yellen has made it clear that tapering will be linked to economic conditions. The positive economic conditions is likely to lead to a tapering of its quantitative programme. External Commercial Borrowings
  35. 35. External commercial borrowing •As the name suggest: ECB when Indian company borrows money from external (non-Indian / foreign) sources. •Money is borrowed from non-resident lenders. •Via bank loans, fixed rate bonds, non- convertible shares, optionally convertible or partially convertible preference shares etc. •For minimum average 3 years. Who is allowed ? Automatic Route: • Companies except financial intermediaries • Units in Special Economic Zones • NGOs engaged in micro finance activities Approval Route: • Infrastructure or export finance companies such as IDFC, IL&FS, Power Finance Corporation, IRCON, Power Trading Corporation and EXIM Bank. • Bank and Financial institutions which participated in the textile or steel restructuring package. • NBFCs to finance import of infrastructure equipment for leasing. • Multistate Co-operative society engaged in manufacturing activities ECB money cannot be used for? •share market or real-estate speculation. •Acquiring another company •Working capital, general corporate purpose and repayment of existing rupee loan Agency 2013-14 ( Projected) 2014-15 (Projected ) World Bank 4.8% 6.2% IMF 4.6% 5.4% UN WESP 5.3% 5.7% Risk: Companies will have trouble repaying their debt denominated in foreign currency Acceptable because economic growth to increase “Rather than administer shock therapy to a weak economy, the RBI prefers to disinflate over time rather than abruptly”- Raghuram Rajan, Governor, RBI Reasons for ECB’s Stable Exchange Rate 12,17011,915 23,006 33,319 22,517 16,738 23,828 36,605 30,249 34,530 0 10,000 20,000 30,000 40,000 ECB Issues Rising Trend in ECB: Sectors like aviation, telecommunication, infrastructure are in dire need of funds Interest rates are lower, even though they are rising
  36. 36. Others Reducing Fiscal Deficit 1. Reduction in payments on external debt 2. Increase in investment by foreign investors. Increase Import duties on Luxury goods and non- essential items Examples: Luxury cars, televisions, laptops, high- end mobile phones, exotic foods etc. Luxury tax will mean increase in import price while relaxation in FDI norms will mean more capital investments. We import around $ 2.1 bn but at the same time that has a dampening effect on local markets Reduce Revenue expenditure and increase expenditure on capital/technology, thus increasing export Revenue Expenditure 86% Capital Expenditure 14% Import most of technical intensive equipment be it mechanical appliances or electrical
  37. 37. Thank You!