By Jahnavi Prabhakar
As the flashing light of New Year has beckoned upon us, it is time we see and understand what has gone past in this last year. It is time to acknowledge those hard points and to understand the reasons behind it. Indias economy in this last one year has witnessed upheaval, which if not realized soon enough would elaborate those frictions that are already a part of the economy. There are some factors which require greater and deeper understanding, lets look at each one of them in more specific and detailed manner.
Current account deficit
In its eighth Financial Stability report, RBI has pegged the current account deficit to be below 3% of GDP, for this fiscal. Last year CAD was recorded at an all time high level of 4.8% of GDP or $88.2 billion owing to heavy trade deficit and gold imports. Before moving further it is imperative for readers to understand what exactly is CAD and why it is of so much concern. It simply refers to the imbalance that country faces, when the value of goods and services of its imports exceeds by the value of goods and services of its exports. Apart from covering exports and imports, current account includes net income in the form of interest and dividends. It also includes foreign aid and transfer income. It implies that the country is investing more than it is saving and is using external resources such as debt, so as to finance and meet its needs. It is highly important because poor and developing countries are usually faced with situation of rising CAD. India being a developing country is no stranger to this. A rising CAD would simply entail heavy burden on the government due to rising debt which would lead to slower economic growth and development. It has also been seen that advanced economies like United States too suffer from this current account deficit, but due to its low levels it is not much of a concern for them, as it is for India and other developing economies. Finance minister is of the view that by this fiscal, CAD would not deteriorate further and would not rise beyond $60 billion. At this point, two more indicators can be brought into the picture these are:
Gold and Indian Rupee
It was in the year 2013 that the world witnessed sharp decline in the price of yellow metal. Bullion slid by as much as 28% last year since 1981 to reach 1182.27 dollar an ounce on 31st December. The metal which has shining brightly for a very long time was now losing its sheen. Gold had always been important and valuable source of investment. It was also seen as a safe haven; something, which could even, beat inflation and would rise upwardly over the years. But in 2013, it saw a backlash with its pricing stooping to as low as it was seen in previous decade. In Indian context, Gold turns out to be more valuable and holds religious values as it is bought during festival season. India imports gems and jewelry from other countries.
Indian rupee recoded its steepest fall of 11% in 2013, with its lowest level of 68.85 rupee per dollar seen in last August. This was due to rapid depreciation of currency. Currency depreciation refers to falls in the value of home currency when compared to foreign currency. For example: 1 U.S$=Rs 62 and 1U.S$= Rs 68. When value of a dollar rises from Rs62 to Rs 68, it simply implies that dollar is dearer/ expensive compared to Indian rupee. It can also be said value of rupee has fallen compared to dollar.
This is what happened in the year 2013, which lead to large hue and cry as rupee depreciated by 11% pulling down its value in the international market. Why does it matter so much if the currency depreciates or appreciates? This has to be understood in a holistic manner. It is demand and supply of currency which determines if the currency would appreciate or depreciate. If there is a higher demand of rupee, the value of rupees would go up comparative to U.S dollar. As the rupee gets weaker, it would leads to unfavorable imports as imports would become costlier. This situation is further aggravated when a country like India which heavily depends on its imports to fulfill its demand for oil as well as gems and jewelry falls into this trap of rupee depreciation. It is interesting to see that due to some restrictions, products like coal and iron ore have recently been added to the list of imported commodities despite having it in abundance. With the imports are getting costlier; prices of these commodities would automatically shoot up. This would put pressure on the domestic economy and would lead to high inflation. In such situations, foreign investors too become cautious and start pulling out their money as falling rupee is no longer attractive enough for the investors. Capital inflow would reduce and put pressure on currency to depreciate further.
Though this weak rupee would make Indian goods more competitive in world markets leading to higher exports, India being an import intensive country would not be able to sustain or match growing exports with the level of imports. Imports would again march ahead of exports, thereby putting additional pressure on the economy. The burden would also be felt by the firms who have taken business loan from foreign institutions and with depreciation, this burden would enhance further as they now would have to shell out more money.
In all, depreciation of currency would lead to high imports which include commodities like gold which itself was hard hit in 2013, thereby putting excessive load on current account deficit. This implies that all these factors are interrelated to each other, impact on any one of this factor would create a ripple effect which would have a dampening impact on the economy as a whole. This would bring down the economy with poor and sluggish growth.
Pull-Out Measures
Some corrective measures were taken by the government and RBI (central bank) to pull out the distressed economy. These included hiking import duty of gold so as to discourage people from buying gold which would help in softening import demand. RBI used its tight monetary policy by raising short term interest and by selling bonds through open market operation, to suck out liquidity from the market. For the foreign institutional investors a minimum stay period was also designated which would mean that they would not run away when investment climate is adverse. Also, RBI has reduced the limit for outbound investment and remittances from India, to encourage capital inflow.
It should be noted that that these steps are short term solutions and would not eradicate the problem as a whole, rather they themselves would be creating additional problems. RBI and government were able to tame the currency up to a certain agreeable level. Weaker currency has led to higher levels of exports which have helped in improving or narrowing down the current account deficit. But the inflation levels were beyond repair and have still not improved despite these measures. India also needs to drop its dependency levels on other countries for imports and try to become self-dependent as it is these imports which eats out the current account deficit and adversely impacts the economy. Therefore, it is time to reflect back and see the mistakes which could have been curtailed there and then with a hope of not repeating them in the future. The New Year brings along with it new possibilities and challenges for the economy which should be looked upon with renewed vigor, as there is a lot of scope for improvement.
Jahnavi is working with National council of applied economic Research. She has previously handled projects sponsored by Commerce Ministry, Government of India. She has also worked with National centre for educational research and training.