A finer balance

India's current account deficit has risen sharply to above 5 per cent of the GDP. Finance Minister P. Chidambaram is reported to have reacted to the balance of payment statistics by saying that he may have to increase the import duty on gold. If the solution to the country's balance of payment problems lay in high import duties, India would never have had the 1991 crisis.

Fortunately, in the July-September quarter, the previous finance minister's budget proposals on taxing foreign capital flows were not implemented, otherwise the balance of payment situation could have been much worse. The government should now conduct a stress test capturing the scenario of a sudden drop in foreign investment flows and its impact on the economy. This should form the basis of thinking about a policy framework in which the Indian economy would be resilient to such shocks.

The current account deficit in July-September 2012 stood at 5.4 per cent of GDP. Thanks to foreign investment inflows, both direct and portfolio, India did not witness a sharp depreciation of the rupee during this period. Depreciation would have made the already high inflation worse. It would have put a lot more businesses, already looking for debt restructuring, in greater difficulty. Portfolio inflows between July and September 2012 were $7.6 billion. In the same quarter of 2011, there was a net portfolio outflow of $1.4 billion. Suppose a similar swing takes place in the next quarter — what will be the impact on the economy?

Complacence on the part of policymakers would be a mistake. The total quantities of exports or imports are not determined by the government. Policies can only change incentives to buy or sell globally traded goods and services. If, due to a change in global conditions, there is a change in global financial flows, the current account deficit would be financed by trade credit or debt flows. This could potentially pave the way for a much bigger crisis. There would likely be greater pressure on the rupee to depreciate. The government would, in all probability, step in with a number of knee-jerk reactions to stop capital outflows, to prevent dollar borrowing, to push the RBI to intervene to prevent rupee depreciation, to first impose higher duty on gold and then post additional customs officers as well as have stringent checks at international ports and airports to prevent smuggling. Measures with origins dating back to the licence quota raj will be conjured up, with the hope that this time they would work.

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