External stress returns | Business Standard Editorials

The official data is now available for India’s external account in the third quarter of the financial year 2018-19, between October and December 2018. According to the statistics, the current account deficit stood at 2.5 per cent of gross domestic product, or GDP. A lower price of crude oil flattered the balance of payments, allowing the current account deficit to come down from the dangerously high 2.9 per cent of GDP, which was recorded for the second quarter of 2018-19, between July and September 2018. The overall current account deficit for the period between April and December 2018 stood at 2.6 per cent of GDP, a big step up from the 1.8 per cent of GDP recorded in the same period of the previous year.

India’s long-term vulnerability to fluctuations in the price of oil and gas thus continues to be on display. Unfortunately, Indian exports have continued to be relatively stagnant, meaning that the current account deficit is dependent almost entirely on global commodity prices. This dependence on external energy can only be considered to be a manageable problem if there is solid and sustainable financing of the current account deficit. However, another structural problem appears to be developing in the Indian economy, one which enhances the already problematic vulnerability on the external account. Attracting stable capital flows has become increasingly difficult. Net foreign direct investment has not seen an appreciable increase. In the period between April and December 2018, net FDI was just under $25 billion; in the equivalent period of the previous year, it had been just under $24 billion.

NRI deposits have also largely stagnated. India is thus dependent on hot money flows — portfolio investment, which is subject to the vagaries of international finance. Between April and December 2018, this hot money largely left India. It appears that portfolio investment registered a net drain of capital of almost $12 billion in the period; in the equivalent period of the previous year, there had been a net inflow of almost $20 billion. It is possible that portfolio investment has again reversed in the period since December, but that only underlines the unmanageable and unpredictable nature of such flows. The balance of payments has been in deficit for the third quarter in a row as of December 2018. This indicates that, while the earlier danger zone for the current account deficit, because of strong capital inflows, was at around 3 per cent of GDP, that danger zone has now been lowered. Even a current account deficit of 2.5 per cent of GDP is sufficient to stress the external account in a scenario in which net FDI has stagnated.

It is clear that these structural problems need to be more carefully addressed. The fact that India is nowhere near a crisis at the moment does not mean that there are no signs on the horizon that a crisis has become more probable if conditions were to turn adverse. The next government will have to focus on increasing exports and on creating more attractive conditions for long-term investment in India.

via External stress returns | Business Standard Editorials

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