Current Account Issues
The outflow of funds coupled with negative real interest rates has seen India’s savings gap widen. The current account deficit is now hovering around a record 5.3% of GDP. The Indian government introduced restrictions on gold imports this year, which, along with energy imports, are the major contributors to the deficit. The government imposed import curbs appear to be having an impact with the current account deficit recently showing signs of stabilising. The Reserve Bank of India anticipates the deficit to fall to 3% of GDP in 2013.
The modest improvement in the current account deficit has largely been the result of better trade figures. The trade deficit reached a 30 month low in September before widening in October, primarily the result of festival-induced gold demand. Despite this, gold and silver imports are down 80% on year ago levels. The Rupee should also benefit indirectly from falling oil prices given the fact that oil refiners financing crude oil imports are the largest buyers of foreign currency. Alongside the improvement in import performance, exports have grown for four consecutive months.
Mitigating Factors
Ratings agency Standard & Poor’s have recently noted the potential for a credit rating downgrade if the policy agenda of the newly elected government in early 2014 isn’t sufficient to generate better growth prospects and turn the government’s fiscal deficit around. From the government perspective, there has been some progress, with the Indian budget deficit totalling 5.8% of GDP, down from over 7% of GDP in late 2011.
External debt levels have almost doubled over the past five years with the majority denominated in US dollars. The fall in the Rupee has therefore increased the servicing costs. However, the amount of Indian Rupee debt as a proportion of total external debt has fallen from around 15% to 25% over the same period.
A key indicator that signals the potential for an external crisis, is the ratio of reserves to external debt. According to the Indian government, the ratio has fallen from 109% in 2005/2006 to around 75% in 2012/13. While the decline in reserve cover is negative, there are mitigating factors and the situation is improving. A large part of the increase in external debt has resulted from a rise in shorter-term debt related to trade credits.