CAD's bad, real bad: and external debt is looking worse

By Raghavan Jagannathan

The bad news: reality has proved to be scarier than expected. The country’s current account deficit (CAD), the difference between our external earnings and expenses before capital flows, hit an unheard-of 4.5 percent of GDP in the last quarter of 2011-12 (January-March). For the year as a whole, CAD hit 4.2 percent of GDP. This is quite simply unsustainable.

India also saw a huge jump in its external debt by nearly $40 billion in 2011-12 - clearly suggesting that we are borrowing more to pay our import bills. Our foreign debt now exceeds our foreign currency reserves by nearly $90 billion - which means we have to no room for complacency.

In the context of the Reserve Bank’s moves to further increase external borrowing in order to bring in short-term capital flows into the country and boost the rupee, we are probably building up problems for the future - unless exports can be shored up (read here ).

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The good news: CAD may have peaked. It could even drop dramatically this year, if the world goes into a tailspin. Reason: as oil and commodity prices crash with a global recession, India’s import bill, which is the prime cause of the high CAD, will tumble.

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According to a report in Business Standard, the import bill could fall by a dramatic $60 billion in 2012-13 - around $25 billion due the crude price fall (if it holds), and around $20-22 billion in terms of lower gold and silver imports (due to rupee fall and higher taxes). The rest of the $60 billion will come from chemicals import compression and other products.

An analysis by Goldman Sachs’ chief economist Tushar Poddar, put out before the CAD figures came in, and published by Firstpost, says that CAD could fall to 3.5 percent this year due to the oil price slide. While the rupee depreciation would make exports more competitive, declining oil prices would make imports cheaper.

“Our analysis shows that the sharp depreciation of the INR in real terms can help improve the trade balance significantly. Our estimates show that every 1 percent real depreciation in the INR leads to a 1.1 percent increase in exports with a lag of two months and a similar fall in imports after four months,” says Poddar in his report. (Read the story here).

The Reserve Bank of India (RBI), which put out the latest balance-of-payments data on Friday, said that the full-year’s CAD for 2011-12 was a hefty $78.2 billion - up more than $30 billion from the previous year. In the fourth quarter (January-March 2012), the CAD deterioration was particularly acute, with exports decelerating and import growth staying stubbornly high, resulting in a gap of $21.7 billion.

Thanks to the growth in CAD deficit, India has been boosting its external borrowing to pay its bills. Not surprisingly, in 2011-12, India’s external debt as at the end of March 2012 had risen to $345.8 billion (20 percent of GDP), nearly $40 billion more than the debt at the end of March 2011 (See the date here).

As opposed to that, the country’s foreign exchange reserves (excluding gold and SDRs) stood at around $256 billion - a gap of nearly $90 billion. India’s external front has clearly significantly deteriorated in 2011-12.

But if the rupee stays down against the dollar, it could be the author of a turnaround in CAD in 2012-13. On Friday, the rupee, buoyed by expectations of strong action by the PMO to lift the gloom and better news from the eurozone, closed at 55.20 to the US dollar.