CURRENT ACCOUNT DEFICIT

TRENDS & REMEDIESBy:Sumanth Patlolla (50A)Sanjeev Kumar (42A)Pratik Godhane (35A) Nikhil Indla (29A)Gukan K (18A)Anand Savur (8A)-----------------------------------Vidooshi Joshi (55A) Sachin Gupta (38A)Manasi Jain (23A)Devansh Doshi (16A)Aniruddh Srivastava (9A)Abhay Sharma (1A)

AgendaAb

out C

AD

DefinitionHistoryPast trends Fa

ctor

sHigh importsWeak exportsTwin deficitGrowth and GDP

Impl

icati

onsDepletion of forex

Rupee DepreciationWeakening Investment sentimentInflationMonetary policy M

easu

res &

Res

ults

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d Re

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About CADBRIEF INTRODUCTION AND LOOKING AT THE PAST TRENDS

Definition Current Account – sum of

◦ Balance of Trade - export minus import of goods and services◦ net factor income such as interest and dividends ◦ net transfer payments such as foreign aid.

Current Account Deficit◦ Associated with trade deficit of a country (Imports > Exports)◦ Represents a net negative sales abroad◦ For developing economies, transfer payments are important in terms of

◦ Donations, Workers’ remittances, Grants and aids, Official Assistance

History of CAD in India 1991 crisis is remembered as the BOP crisis but it was essentially a Twin Deficit problem

India was unable to finance its CAD through capital inflows being a closed economy

Symptoms & challenges – ◦ A CAD larger than the debt inflows◦ Import cover nose dived to a mere 2 weeks in 1990-91 ◦ Fiscal deficit was at a high of close to 9 percent with persistently high revenue

deficits◦ Inadequacy of external funds to boost investment at a time when the

government deficit had “crowded out” ◦ The production sector unable to help in reducing the deficits.

The twin deficits created a much bigger BOP issue which forced India to take assistance from IMF and Bank of England.

Past trendsThe sharp decline in CAD in the past years is alarming because of –

• instability of Foreign Institutional Investment

• slowing down of FDI

• threat of recessionary trends in the developed economies

Source: Voice of Research; Paper by Sachin N. Mehta

Past Trends Average (1949 – 2013) : - 1.62 USD bn

All-time high (March 2004) : 7.36 USD bn

All time low (December 2012) : - 31.86 USD bn

Source: www.tradingeconomics.com

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FactorsMAJOR REASONS FOR HIGH CURRENT ACCOUNT DEFICIT IN INDIA

High imports – Crude oil Oil imports leapt by 40% in 2011-12 due to

◦ Weak rupee◦ High rates of

crude oil in Int’l Markets

◦ High demand in domestic markets

Oil imports constitute a third of India’s imports and half of its CAD

Source: Ministry of Petroleum & Natural Gas

High Imports - Gold Constant rise in –

◦ Value of gold imports◦ Share of gold imports◦ Amount of gold imports

This was because, people started investing in physical assets such as gold and real estates to hedge their risk against price rise

High Imports

Weak exports Global economic slump and general deceleration in world trade saw a drop in exports of India in 2008-09

Iron Ore –◦ India exported 117 mt in 2009-10

but only 18 mt in 2012-13. 2013-14 is likely to see India becoming a net importer of Iron ore

◦ Shift from third largest exporter to importer mainly due to ◦ Cap in production in Karnataka◦ Ban in Goa◦ Strict environment regulation in Orissa due

to SC rulings and State interventions

Invisibles, or services which dampened CAD until recently have also lowered

Rise due to recession in developed countries leading to fall in rupee

Twin deficit High CAD and Fiscal Deficit worsen each other

Can be proved by –◦ Mundell-Flemming

Model◦ High Govt. spending = Upward

pressure on Interest rates◦ More inflow of foreign capital◦ Currency appreciation◦ Fall in Net Exports = Trade

Deficit◦ Keynesian Theory

◦ X-M = (S-I) + (T-G)

Fiscal deficitTrade deficit

Growth & GDP Indian CAD is counter-cyclical i.e. it rises when output falls and not when demand rises

Due to low growth, imports have risen mainly to meet domestic demand instead of supporting economic growth

This has put the economy on dangerous footing

ImplicationsBIGGEST IMPACTS IN IN THE INDIAN SCENARIO FUELLED BY HIGH CAD

Depletion of Forex Reserves Deficit on current account means net outflow of foreign capital i.e. $ outflow in India’s case

Without equal or more amount of inflow, a deficit puts strain on a country’s foreign exchange reserves

Which is why, India is so keen on FDI as it needs the foreign inflows to keep it’s current account deficit in check

Due to existence of CAD, rupee has depreciated as a result of inflows being lesser than outflow of foreign capital

Source: RBI

Depreciation of RupeeFirst and foremost implication, as we have been observing in the past couple of years is the depreciation of rupee which, in turn, results in a number of consequences as listed in the adjoining diagram – resulting in a viscous internal cycle.

While depreciation boosts exports, the effects are quite delayed and uncertain.

Currency fluctuationsSource: www.tradingeconomics.com

Weak Investment Sentiment 2013 saw a capital flight out of India, especially in 2Q of 2013-14

This was due to weakening rupee

It is important to maintain this inflow as it is currently responsible for maintaining the current account balance

A high CAD has also led to decline in India’s credit rating, directly affecting investment

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Total Foreign Direct Investment in India

Source: RBI

Inflation A simultaneous and add-on affect of high fiscal deficit on CAD and a weakening rupee

Inflation caused a steep decline in household savings in 2008-09 – and a rise in savings of physical assets, thus reducing the liquidity in the market

This, in turn, resulted in greater demand for gold – raising its imports and fuelling an already soaring CAD

Impact on Interest Rates India has one of the highest interest rates in the world

Interest rates have been raised since 2010 in order to curb inflation

Hence, it is an indirect implication of a high CAD

Growth has been sacrificed in the process

Measures takenHOW GOI MANAGED TO BRING DOWN CAD

Measures & Results Measures –

◦ Govt. increased taxes on gold in the world’s biggest user of the metal 3 times to balance the trade level which weighed down rupee

◦ Steep fall in rupee boosted exports◦ Merchandise exports picked up ◦ Concessional dollar swaps for lenders to spur inflows in order to support rupee after the steep fall in

August

Results –◦ CAD has reduced significantly and is more manageable now◦ Hence, movement of Rupee is no longer about CAD but capital inflows – dependent on the behavior of

global markets

Results quantifiedSource: RBI

Suggestions & RemediesWHAT ELSE CAN BE DONE?

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petroleum import CAD

Address the Petroleum Issue

80% oil ImportedNet Oil Import : $109 billionTrade deficit $196 BillionCAD: $88 Bn, 4.8% of GDP

Increase Energy efficiency levels: Case In Point JAPAN

Share of Oil has decreased from 77.4 % in 1973 to about 45% now

Deregulation of oil prices: Slowly remove the subsidy

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Transport Industry CommercialDomestic Agriculture

$12 Bn Subsidy 2012Govt. has started stepsInnovation & conservation

Address the Petroleum IssuePut more tax on excessive use of oil: Bring in Incremental Pricing

More incentives for growth of renewable sources of energy: a level playing field

Reduce incentives/increase taxes for the transportation industry: Innovation

Alternative sources in Shale gas and oil, Bio fuels, Bio Gas

32%

68%

Shale Oil & Gas Non-Shale

coal41%

oil29%

nat-ural gas9%

hydro powe

r3%

nuclear power

2%other 15%

coal oil

natural gas hydro power

nuclear power wind power

other Bio Fuel ProgrammePricing of EthanolBio Diesel

Shale Gas: Assam, Arunachal Pradesh, Nagaland And Manipur

Reduce Gold Demand

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Jan 21: Import raised from 4% to 6%

Jun 5: Import raised from 6% to 8%

Aug 13: Import raised from 8% to 10%

About 400 tonnes of recycled gold to enter the market this fiscal year to March 2015, compared with normal rates of about 130 tonnes, according to Thomson Reuters GFMS data

Review gold/gold doré import on a quarterly basis to set the agenda

Promoting national savings to fund investment. Schemes like the Rajiv Gandhi Equity Savings Scheme (RGESS) and the recently implemented Inflation Indexed Bonds (IIBs) to wean away investors from gold

Allocate quarter import quota to agencies and let them bid for the gold on quarterly basis.

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sensex gold

Export Diversification

Economic RisksShort term: Volatility and instability in foreign exchange marketsLong term: Unpredictable declining terms of trade trends

Political Risks: Poor governance, risk of civil war

• Reduce dependence on a few geographical entities • Expanding opportunities for export and improvement of backward and forward linkages to domestic inputs and services

West Asia- GCC 16.9952 North Africa 1.8914

EU Countries 16.7848 Southern African Customs Union (SACU)

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North America 13.2556 Other European Countries

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NE Asia 13.1117 Other CIS Countries 1.0424

ASEAN 10.9881 East Asia (Oceania) 0.9097

South Asia 5.0302 Other South African Countries

0.6279

Latin America 4.5 European Free Trade Association (EFTA)

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Other West Asia 3.7803 Central Africa 0.3099

East Africa 2.9425 CARs Countries 0.1835

West Africa 2.1716 Total 100

IndiaChina

PhilippinesMexicoNigeria

EgyptBangladesh

PakistanVietnamUkraine

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Remittances ($ billion)

Remittance is the act of transmitting money to a distant location to fulfill an obligation. International remittances are transfers of funds by foreign workers—remitters—who are living and working in other countries typically to their families who are still living in their home countries

• From a BOP perspective, remittances are permanent foreign currency inflows and help finance the current account, unlike NRI deposits which are repatriable

• Part of these inflows get invested in stocks, bonds, fixed deposits and real estate• India received an estimated $71 billion (around Rs.4.4 trillion) in remittances last year (up from $69 billion in 2012) and much higher than China’s $60 billion

• In India, remittances are larger than the earnings from IT exports and just under three times of the FDI received in 2013

• Weakening of the Indian rupee is usually followed by a surge in remittances since NRIs are expected to take advantage of the cheaper goods, services and assets back home

Sources: Reserve Bank of India, IMF Balance of Payments and Bank staff estimates

Foreign Remittances

Attract FDIFDI inflows are long term investments by overseas company setting up manufacturing and other commercial enterprises in India and hence represent more stable and dependable form a finance

• Match FDI policy with Import duties, in such a way that rise in import duties acts as incentives to foreign direct investment in that particular sector

• India also needs to focus on long-term foreign direct investment, which is sticky

FDI inflows into India contracted by 38 per cent to $22.42 billion in 2012-13 compared with $35.12 billion of FDI inflows the country witnessed in 2012

Source: DIPP

Factors holding back FDI investment in India

Tepid economic growthLack of transparencyLack of consistency in FDI policiesRegulatory hurdlesInfrastructure Deficiencies

Foreign investment into India falls under one of two FDI routes:Government Route: For investment in business sectors requiring prior approval from the Foreign Investment Promotion Board (FIPB).Automatic Route: For investment in business sectors that do not require prior approval from the government, but the filing of a notification after the incorporation of the company and issue of initial shares.

Government efforts to increase FDI include:

1) SEZs/EHTP/STP/BTP/NIMZ’z etc

2) Raising FDI cap in sectors like multi brand retail

3) Increasingly shifting the approvals under automatic route

Solutions

Open up new sectors like insurance and pension fundsEase regulatory hurdles through administrative reforms

Significant investor segment of the Indian capital markets, accounting for on an average 20% of the turnover in both the Indian equity and debt markets

Increasingly been bridging the funding gap on the country's current account deficit. Also widely accredited for the high-speed growth in the Indian capital markets i.e. the equity market segment

RBI’s enhancement on the limit of investment in government securities (G-Secs) by foreign institutional investors (FIIs) and long- term investors by $5 bn to $25 bn from $20 bn

RBI’s change in rules to make it easier for foreign and NRI promoters to raise stake in listed Indian companies

SEBI’s permission for FIIs to buy government bonds without purchase permits from it until overall investment reaches 90%

Attract FII

At a time of 'global risk aversion', when investors are fleeing to safe havens, it becomes difficult to attract equity flows to a country like India, especially one with a weak currency, shaky current account, and uncertain macroeconomic outlook. Attracting investment through the ECB route becomes an instrument of choice.

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Recovery

EU GDP% US GDP%

The US Federal Reserve Chairperson Janet Yellen has made it clear that tapering will be linked to economic conditions. The positive economic conditions is likely to lead to a tapering of its quantitative programme.

External Commercial Borrowings

External commercial borrowing•As the name suggest: ECB when Indian company borrows money from external (non-Indian / foreign) sources.•Money is borrowed from non-resident lenders.•Via bank loans, fixed rate bonds, non-convertible shares, optionally convertible or partially convertible preference shares etc.•For minimum average 3 years.Who is allowed ?Automatic Route: • Companies except financial intermediaries • Units in Special Economic Zones • NGOs engaged in micro finance activities Approval Route: • Infrastructure or export finance companies such as IDFC, IL&FS, Power Finance Corporation, IRCON, Power Trading Corporation and EXIM Bank. • Bank and Financial institutions which participated in the textile or steel restructuring package. • NBFCs to finance import of infrastructure equipment for leasing. • Multistate Co-operative society engaged in manufacturing activities

ECB money cannot be used for?

•share market or real-estate speculation.•Acquiring another company•Working capital, general corporate purpose and repayment of existing rupee loan

Agency 2013-14 ( Projected)

2014-15 (Projected )

World Bank 4.8% 6.2%

IMF 4.6% 5.4%

UN WESP 5.3% 5.7%

Risk: Companies will have trouble repaying their debt denominated in foreign currency

Acceptable because economic growth to increase

“Rather than administer shock therapy to a weak economy, the RBI prefers to disinflate over time rather than abruptly”- Raghuram Rajan, Governor, RBI

Reasons for ECB’s

Stable Exchange Rate

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ECB

Issues Rising Trend in ECB:

Sectors like aviation, telecommunication, infrastructure are in dire need of funds

Interest rates are lower, even though they are rising

OthersReducing Fiscal Deficit

1. Reduction in payments on external debt

2. Increase in investment by foreign investors.

Increase Import duties on Luxury goods and non-essential items Examples: Luxury cars, televisions, laptops, high-end mobile phones, exotic foods etc.Luxury tax will mean increase in import price while relaxation in FDI norms will mean more capital investments.We import around $ 2.1 bn but at the same time that has a dampening effect on local markets

Reduce Revenue expenditure and increase expenditure on capital/technology, thus increasing export

Revenue Expendi-ture86%

Capital Expendi-ture14%

Import most of technical intensive equipment be it mechanical appliances or electrical

Thank You!