Has India's current account deficit been tamed?

For improvement to sustain in FY15, the govt has to retain gold curbs and keep currency from appreciating

One thing India can cheer about this year is the improvement in the current account deficit (CAD), on the back of a clamp on gold imports and a moderate pick-up in exports. Between April 2013 and January 2014, imports contracted $32 billion, while gold imports declined $20 billion compared to the previous year. For the full year, government expects CAD to be $35 billion. An additional savings of $10 billion came from lower capital goods imports, thanks to weak investments. Lower crude oil prices have also come to the rescue during the financial year, say economists. Is this improvement in CAD sustainable?

Granular data on India’s external trade indicate much of the improvement is due to lower imports of gold and capital goods, says Kotak Institutional Equities. Gold imports fell from $7.7 billion in May 2013 to $1.4 billion in January this year. The monthly run rate of gold imports in value terms has remained above $5 billion since January 2012.

On the rupee’s recent appreciation, Scotia Bank’s senior currency strategist Sacha Tihanyi says government measures to stem gold imports have achieved a much better balance across the external accounts. The improvement in the external sector is being viewed as “temporary” and not “sustained”. If it has to sustain, gold import curbs cannot be removed or relaxed in FY15.

The other big factor that contributed to the improvement in CAD is the fall in capital goods imports, which declined to $40 billion during April-January FY14 from $48 billion in the previous year. In calendar 2013, capital goods worth $58 billion were imported. Slowing growth has led to a decline in imports of these goods, but a pickup in growth can easily reverse this, believe economists.

The external sector also improved because of exports, which showed an uptick between April and October 2013 but started contracting since. With the rupee appreciating steadily in 2014 on capital flows, economists believe export growth might be capped. Also, the real effective exchange, which gives a sense of a country’s trade competitiveness, seems to indicate the rupee is undervalued.

Economists believe the Reserve Bank should not let the rupee appreciate beyond 60, as it would come with higher risks of depreciation. Bank of America Merrill Lynch asks if a new regime in 2014 at the Centre would lead to the rupee’s appreciation to 55 against the dollar. The brokerage says this would risk depreciation again, say, 68 to a dollar — if the dollar rebounded against the euro by December 2014 and outflows happened. The downside risks still seem to outnumber the upside risks to India's external account. Sanjeev Prasad of Kotak Institutional Equities believes lower crude oil prices, continued restrictions on gold imports, and exports are India’s best hope for FY15.