As the country’s current account deficit (CAD) hit new records in recent months, the official response to it has been predictable — “It is all due to gold. If Indians were to stop importing so much gold, we wouldn’t have a record CAD”.
Often, this claim is also buttressed with ‘statistics’ showing that the CAD would shrink to one-fourth its level, if we were to do without gold imports. But there are two flaws with this argument.
One, try as we might, India’s gold imports are never going to fall to zero. No matter how economists see it, Indian buyers view purchases of gold jewellery towards weddings or festivals as essential. Therefore, even with all the curbs and appeals, gold imports may subside to about 8-9 per cent of India’s import bill, the long term level, but may not fall below it.
Two, the greater worry is that, in this obsession with gold imports, policymakers are losing sight of the more disturbing aspects of the rising CAD. There are three particular concerns.
Rising energy imports
If gold makes up 10 per cent of the country’s import bill, oil already makes up 37 per cent. Its contribution is rising. Growing oil imports are not just a function of more SUVs on the roads. They are a symptom of the growing energy deficit to power all forms of industrial activity. India is reliant on imports for almost all forms of energy — be it fuel oil to power industries, coal to be used in cement, steel and power plants or liquefied natural gas to feed fertiliser units. Even a couple of years ago, an end to some of these energy woes was in sight with Reliance Industries readying to ramp up gas production at its KG D6 field. Those hopes are now fading with the Government haggling over the price of gas and Reliance claiming that production isn’t likely to rise anytime soon. The ethanol-blending programme, another small but viable source of savings on fuel, seems to be stuck in similar wrangling between the oil and sugar companies.
Where’s export growth
One of the clear reasons for the shocker of a CAD in the latest December quarter was negligible growth in exports. It is tempting to dismiss the poor export growth over the past one year, as a consequence of the brewing crisis in Europe or elsewhere. But the fact is that India hasn’t hit upon any new ideas to grab a larger share of world trade since it discovered software services way back in the nineties. Software services, after delivering remarkable growth for several years, clearly cannot continue to grow at the 30 per cent plus rates forever.
And dissecting the composition of manufacturing exports from India over the last five years reveals a dismal picture. Sectors which have traditionally delivered high export growth — such as diamonds, jewellery and textiles — carry low value addition and even less pricing power. This is clear from the fact that even sharp rupee depreciation over the last three years hasn’t led to material increases in competitiveness for these players.
The area where India has registered surprisingly good export growth is, perversely, industrial raw materials such as iron ore, petroleum products and so on. These could surely fetch better realisations if used to manufacture products.
In any case, the ban on iron ore mining has put paid to this segment and is one of the key reasons for sluggish export growth.
Foreign debt repayments
Healthy inflows from foreign investors, in the form of foreign direct investments and portfolio investments, have helped India fund its CAD without any troubles in recent years.
Net capital inflows, at nearly $32 billion in the December quarter, recorded a healthy 33 per cent rise over September. But 60 per cent of these inflows came, not from Foreign Direct Investment or even equity flows, but from FII investments in debt, external commercial borrowings and other forms of loans.
Why is this, a problem? Well, unlike FDI or even equity, where the money may remain invested in India for perpetuity, loans by their very nature will have to be repaid after a fixed term. The question is, will India’s balance of payments (BOP) position be comfortable enough at any point in time to meet those obligations? Already, many Indian companies have avoided defaults on Foreign Currency Convertible Bonds by re-financing these bonds with new loans. But this shifting of goalposts has to stop somewhere. Hopefully it won’t be when India is poised on the brink of yet another BOP crisis!
All this suggests that the rupee is headed down a slippery slope. So, what can you, as an investor, do about it? Diversify and hold some of your portfolio in non-rupee denominated assets. And yes, if you find foreign funds too complicated, there is always the unpatriotic option — gold.