CURRENT ACCOUNT DEFICIT AND ITS CAUSES

The RBI's report on India's balance of payments during the second quarter(July- September 2012) pegs the Current Account Deficit as a percentage of GDP at an unpresedented 5.4%, up from 4.2% a year ago.

The widening merchandise trade deficit- the fall in exports being greater than the fall in imports- compared to the previous year is one obvious reason.

India's exports have been declining month after month, as a prospects of a revival in the principal markets of the developed world have not improved. Import of 2 commodities, Gold and Petroleum, have remained sticky and account for a substantial portion of the imbalance.

Various measures adopted by government and the RBI to curb the demand for Gold have had limited success. Past experiences suggests that measures such as physical controls will be counterproductive and encourage illegal trade.

One obvious effective short term measure is to increase the Customs Duty on Gold imports. During 2011-12, Gold imports amounted to a foreign exchange spending of $56.2 billion and to curb the rising demand the then finance minister, in his budget for current fiscal, had doubled the basic Customs Duty on standard Gold bars to 4% from 2% and on non-standard gold to 10%. Even as certain other measures had to be moderated, the hike in duty did lead to some decline in imports.

The widening CAD was financed without drawing on country's Foreign Exchange Reserves, mainly because of adequate inflow of FDI($12.8 billion) and FII($1.7 billion). The net result is that "we have not drawn on the foreign exchange reserves and, infact there is a marginal accretion of $0.4 billion to the reserve", said Finance Minister P.Chidambaram. But the question is how long can this continue.. ?

One promising route, though relevant only for long term, is to popularise gold based financial products to wean away consumers from their old preferance for Gold.

Growth in private transfers notably remittances, has been weak, increasing by just 2.3% in the second quarter of 2012-13 compared to over 20% in the corresponding period last year.In the past these and earnings from software exports have cushioned the trade deficit. Their marginal growth has once again exposed the external sector to a dangerous dependence on short term inflows from Foreign Institutional Investors.

Mistaken Government policies are partly responsible for the big jump in India's external debt to $365.20 billion as at end September, up by nearly $20 billion a quarter earlier.