Wages of complacency

India's structural weakness on external account unaddressed

For some weeks, India's external sector has not looked as weak and as crisis-prone as it did at the height of the summer, when fears that the United States Federal Reserve would taper its vast bond-buying programme had exposed how dependent India was on foreign financing. However, it should always have been clear that this was merely a lull, and the fundamental problems highlighted in that period have not gone away. Indeed, the action taken by the government to address the problem, far from being long-term and sustainable, consisted of quick fixes. One such move was restrictions on gold imports: duties were raised considerably. Naturally, smuggling picked up immediately, and such restrictions cannot be continued for long without creating an entire criminal infrastructure devoted to circumventing the law, as had existed in the closed-off India of the 1970s. Another such quick fix was to set up a special currency window for oil importers, which essentially kept Indian purchases of dollars in order to buy oil off the spot foreign exchange markets. Again, this is not a measure that can be used indefinitely; oil companies need more than $8 billion a month to pay for their imports. Another short-term way in which this was being accomplished was through facilitating swaps between foreign currency non-resident deposits in banks and banks' overseas currency borrowing. This is due to be wound up at the end of the month. In these cases, the government of India cannot go on underwriting currency risk forever.

The rupee has lost around 1.5 per cent of its value against the dollar in the last five days, reflecting the dollar's increased strength against emerging market currencies, among other things. Economic Affairs Secretary Arvind Mayaram has said that part of this is due to "30 to 40 per cent" of the oil companies' dollar demand now being met through the spot markets. Thus, this pressure will only intensify. Mr Mayaram insists that strong dollar inflows will continue. In doing so, however, he merely reiterated the degree to which the structural dependence on high dollar inflows has been maintained rather than dismantled. No sequence of short-term fixes will address that underlying problem. And it is worth noting that, whatever the timeline of the Fed's taper, it will eventually become a reality; and, at that point, India's external weakness will again be brutally exposed.

What has remained the same - and what is changing - about India's external account situation was also revealed in the data on India's trade deficit that were released by the government on Monday. In October, the trade deficit was $10.6 billion, down from $20 billion in October 2012. Total oil imports are still growing, however. The structural vulnerability remains. The only cure for this, of course, is to allow an orderly depreciation of the rupee in such a way that the currency finds its true value, and enabling India's exporters to write clear contracts that minimise currency risk and let them open up new markets for Indian products. From that point of view, there was a sliver of good news: merchandise exports in October rose 13.5 per cent year on year. They rose for the fourth month in succession. The only fixes for external weakness are structural: a consistently cheaper rupee, reducing the costs of doing business, and facilitating trade through a multilateral simplification of regulations. The government must work on making all three things a reality.