Strong recovery

But complacency about external weakness should not creep in

The balance of payments numbers for the third quarter (October-December) of 2013-14 were published by the Reserve Bank of India (RBI) last week. Earlier, these numbers would have been published at the end of March, following a quarterly lag, but the external upheavals of last year induced a change in tack; if the news is good, it's never too early to release it. So it was with these numbers, with the current account deficit - the villain of the piece in last year's currency turbulence - shrinking dramatically to $4.2 billion, or less than one per cent of gross domestic product, from over $30 billion (more than six per cent of GDP) in the corresponding quarter of 2012-13. This takes the cumulative deficit for three quarters of 2013-14 to $31.1 billion (2.5 per cent of GDP), in contrast to $69.8 billion (5.2 per cent of GDP) in the first three quarters of the previous year. Two factors are primarily responsible for this dramatic turnaround. First, rupee depreciation has caused exports to accelerate, clocking 7.5 per cent in the third quarter. This has also caused imports to decline, a tendency that was hugely reinforced by the second factor - a huge fall in gold imports. These were as low as $3.1 billion in the third quarter, compared to almost $18 billion in the third quarter of 2012-13.

On the capital account, after the trauma of May-September 2013, things have also turned around quite nicely. The return to stability in global capital flows towards the end of last year facilitated investor re-entry into markets, which offered some prospects of currency stability; India, with the sharp narrowing of the current account deficit, was in the forefront of this process. Capital inflows were comfortably ahead of the current account deficit in the third quarter, with a notional accretion to foreign exchange reserves of almost $20 billion. In effect, the narrowing deficit has triggered a virtuous circle, inducing expectations of currency stability, which in turn encourages larger investment flows.

In short, there is a sea change in the situation compared to nine months ago, when the large deficit made the rupee vulnerable to even a moderate shock. That is clearly not the case now and the finance ministry and the RBI deserve credit for having got to grips with the situation and reduced the level of vulnerability in a relatively short time. As suggested above, some of the improvement is the predicted narrowing of the trade deficit as a result of rupee depreciation. But the restrictions imposed on gold imports also worked well. Of course, there is evidence to suggest that some gold is coming in through informal channels. The government would be well advised to nip this in the bud by steadily easing the constraints on official imports. Even as this is being done - it will also be a confidence booster - it should not be forgotten that the triggers for the enormous surge in the current account deficit in 2011-12 and 2012-13 were the sharp decline in iron ore exports and the equally dramatic increase in non-coking coal imports. These two pressure points remain entrenched. As comforting as the third quarter numbers may be, external vulnerability lies in wait just below the surface. Complacency mustn't take the focus away from structural problems.