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India's current account vulnerability falls, but risks remain

December 04, 2013 12:52 IST

CADMeasures to curb demand for imported gold have contributed to a sharp narrowing of India's current account deficit, global consultancy firm Capital Economics said.

"This should make the rupee less vulnerable to shifts in global investor sentiment," it said in a report released on Wednesday.

Preliminary balance of payments data published on Monday showed that the current account deficit fell to $5.2 billion in the July-September quarter of 2013-14, or 1.2 per cent of gross domestic product.

"The decrease was due to a pick-up in exports and a slump in gold imports, it noted.

Gold imports have risen substantially over the past decade from $5 billion in 2003 to over $50 billion in 2012, it said.

"India's affinity for gold is partly cultural but a desire to hedge against inflation has also played a role," the report said.

The decline in gold imports was the result of policy changes, such as a requirement to re-export 20 per cent of imported gold and a doubling of import duty, that were introduced to make India less vulnerable to any shift in foreigners' willingness to fund India's deficit spending.

"These moves, so far anyway, have proved extremely successful," it said.

Thanks to weaker gold demand, India was able to accommodate outflows without cutting spending elsewhere or drastically running down its foreign exchange reserves, the report said.

Looking ahead, reduced dependence on foreign financing should leave India far less vulnerable to any shift in global investor sentiment.

The rupee should be more stable as a result, it said.

But a few caveats are in order.

First, the current account can be volatile from quarter to quarter.

"Appetite for gold may also return.

"Some imports may just have been deferred on anticipation that the government might reverse its crisis-response policies," it said.

Certainly, over the last decade, higher domestic gold prices have over the medium term gone hand-in-hand with higher demand, so the policy measures which have pushed up domestic prices may not restrain demand indefinitely.

With consumer price inflation at 10 per cent, the appeal of gold as a hedge against inflation remains intact, it said.

Meanwhile, it remains uncertain how committed the government is to reining in the deficit when this goal conflicts with other priorities, the report added.

"It has been half-hearted at best in its efforts to rein in the budget deficit," it said.

"The risk of fiscal largesse by an unpopular government, which would prop up both the fiscal and current account deficits, remains high in the near term as elections approach," it said.

Gurdip Singh in Singapore
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