Last week, the Reserve Bank of India (RBI) published the balance of payments (BOP) data for the October-December quarter of 2009. It elicited surprisingly little comment. Surprising, because for the second quarter in a row, the current account deficit was well above 3 per cent of GDP. And with nine months data in the bag, there is a good chance that the full year (2009-10) current account deficit will also be above 3 per cent of GDP. If this the case, it will be a first since the pre-crisis year of 1990-91. No, I am not predicting any imminent external payments crisis of the kind we had in 1991 — that would be silly, when RBI is sitting on over $280 billion of foreign exchange reserves. However, we should at least sit up and take serious notice, especially when the 3 per cent of GDP current account deficit is paired with a near 10 per cent of GDP merchandise trade deficit.
Actually, what is really disturbing is that this second successive quarter of above 3 per cent current account deficit has been registered at a time when the exchange rate of the rupee appreciated quite a bit and inflation accelerated. Specifically, the real effective exchange rate (REER) of the rupee, according to RBI’s 6-currency trade-weighted index, appreciated by a full 5 per cent between September and December 2009 (see Figure). Normally, when a country runs a moderately high current account deficit and relatively rapid inflation is weakening its competitiveness, one expects to see a depreciation of its currency to bring about an adjustment in imbalances. The opposite seems to have happened. Moreover, this pattern has persisted throughout 2009-10, with REER appreciating by nearly 15 per cent between March 2009 and February 2010. And the movements in nominal currency rates and price indices beyond February (the last month for which the RBI index is available) suggest further significant real appreciation of the rupee.
The recent surge in the value of the rupee is reminiscent of the sudden, sharp appreciation of the currency in the spring of 2007. At that time, the driving factors were an accelerating surge in capital inflows and a sudden policy shift by RBI (generally believed to have been dictated by the finance ministry) in favour of non-intervention in the currency market. This time, too, similar factors are at work. After the post-Lehman collapse of capital inflows in 2008-09, there has been a healthy rebound in 2009-10. In both the second and the third quarters of 2009-10, net inflows outweighed the current account deficit. And the same pattern may have persisted in the fourth quarter. Furthermore, RBI appears to have adopted a largely non-interventionist stance towards the currency market since last summer. Part of its reluctance to intervene in order to contain rupee appreciation may be attributed to its preoccupation with managing the record borrowing programme of the government in 2009-10, which, in turn, may have constrained its ability to undertake sterilisation of foreign currency purchases.