Current account deficit solution lies with Reserve Bank of India

Many observers have found it difficult to understand why the Finance Minister was acting rather helpless about what can be done to curb the current account deficit. He did say that it is a big worry. In fact, he seemed rather confident about taming inflation and cutting the fiscal deficit to manageable levels, but on bridging the current account deficit, all he could say was that we need foreign direct investment, foreign institutional investment and external commercial borrowings to the extent of $75 billion. On foreign trade, all he said that was that he will support the measures that will be taken to boost exports of goods and services through changes in the Foreign Trade Policy.

I doubt if the changes in Foreign Trade Policy alone will help us tide over the crisis in the external sector. Since the last few years, the Commerce Ministry has been liberally giving away duty credit scrips to exporters. These duty credit scrips can be used for payment of customs duty on imported goods. So imports become cheaper and more attractive and consequently, higher imports not only worsen the current account deficit, but also hurt the domestic industries.

On its part, the Reserve Bank of India is firm on its policy of intervening in the foreign exchange markets only to curb excessive volatility. In fact, the Reserve Bank seems weary of a depreciating rupee fearing that a weaker rupee will worsen the problem of inflation. The view seems to be demand for imported oil, fertilisers and coal being rather inelastic, no useful purpose will be served by a weaker rupee. There is enough room to disagree with the view.

The finance minister said he hoped for growth rate of about 6.4 per cent in the year 2013-14. If the current account deficit is 5.4 per cent of the GDP when the growth rate is five per cent, is it not likely to worsen when the growth rate accelerates to 6.4 per cent? Will more duty credits help contain the deficit? Will the domestic currency strengthened by speculative inflows from foreign institutional investments or external commercial borrowings help?

The official explanation for the slowdown in exports is that the developed economies are in recession. Also, increase in gold imports is being blamed for higher import bill and consequent worsening of current account deficit. How the changes in Foreign Trade Policy of giving more and more duty credits will help curb imports is anyone's guess.

The solution for the worsening current account deficit is with the Reserve Bank. By buying up the inflows whenever the rupee appreciates and not selling when the rupee depreciates, the Reserve Bank can build up its foreign exchange reserves. Buying up the foreign exchange inflows may mean more rupees in the system but greater liquidity may be needed when growth rate is going up.

A weaker rupee will not only help exports become competitive but also provide much needed protection to the domestic industries. It will also help shore up customs revenues. Containing inflation may become more difficult but that seems less difficult now than containing the current account deficit.

Therefore, the Finance Minister should talk to the Reserve Bank Governor and find ways of tackling the problem of ballooning current account deficit through appropriate foreign exchange management policy rather than look to changes in Foreign Trade Policy.

Email : tncr@sify.com