MUMBAI (Reuters Breakingviews) - India’s ballooning trade deficit means it has to run just to stand still. Without steady capital inflows, the currency will collapse. But without a steady currency, it is hard to attract foreign capital. The rupee’s 19 percent fall against the dollar over the past year is worrying.
During most of the last decade, the current account deficit has been funded without great difficulty. Foreign direct investment, portfolio investments and about $60 billion a year of remittances have usually exceeded the shortfall in trade. India has accumulated around $300 billion of foreign currency reserves, equivalent to 17 percent of GDP.
But the annual trade gap has widened from $104 billion to $185 billion. At 3.7 percent of GDP, the current account deficit is the highest since 1980, when the International Monetary Fund starting collecting data. High energy prices are the main culprit for the recent deterioration - oil accounts for two-thirds of the country’s import bill. Of course, the blow would have been less painful if Indian had a stronger export sector.
The support of foreign investors is more necessary than ever, but New Delhi’s mismanagement has discouraged them. Foreigners bought an average of $3 billion a month of Indian debt and equities in the first three months of 2012, according to the Securities and Exchange Board of India’s website. So far in April, they have been net sellers of $403 million.
The currency’s fall threatens to create a negative spiral. More expensive imports are inflationary and put pressure on corporate profits. Government subsidies of domestic fuel prices become more costly, adding to the fiscal deficit, which swelled to 5.9 percent of GDP in the fiscal year that ended in March. Furthermore, the rupee’s slide creates financial stress for Indian companies that have borrowed in dollars.
India’s currency reserves provide a buffer. But if capital flows turn sharply negative the reserves could melt away quickly. And if investors start to believe that the rupee is a one-way downwards bet, they will race for the exit. Predictions of a declining currency - UBS suggested a further 6 percent fall last week - could prove self-fulfilling.
- The rupee hit an almost 4-month low of 52.86 to the dollar on April 24. A UBS report predicted a rate of 56 to the dollar later this year, Reuters reported on April 26.
- Standard & Poor’s cut India’s credit rating outlook on April 25 to negative from stable, reflecting the toll of hefty fiscal and current account deficits and political paralysis on Asia’s third-largest economy. The negative outlook jeopardises India’s long-term rating of BBB-, the lowest investment grade rating.
- A Reuters poll on April 26 showed market players had nearly doubled short Indian rupee bets, the largest change since November.
(The author is a Reuters Breakingviews columnist. The opinions expressed are his own)
Editing by Edward Hadas and David Evans