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Nagesh Kumar: Home remedies for CAD

Domestic market, local innovations and retail can be leveraged to curb current account deficit

Nagesh Kumar 

Indian economy weathered the impact of global financial crisis quite well and continued to grow robustly while some of the most advanced economies were actually contracting. It is now widely seen to be moving back to its pre-crisis growth trajectory with most of its macroeconomic fundamentals in good shape.

One respect in which the emerging trend is not healthy is the balance of trade. The balance of India’s trade has steadily deteriorated and become unfavourable with a deficit of US$ 118 billion in 2009-10. The surplus in invisibles and services trade absorbed some of this deficit to result in a current account deficit (CAD) of $38 billion or 2.8 per cent of GDP. This represents more than doubling of CAD from 1.3 per cent of GDP in just two years since 2007-08. In 2010-11, it may widen further especially with rising fuel prices even though exports have recorded robust growth rate in recent months. In other words, the CAD is moving beyond the healthy limits.

One should hasten to add that the present situation is quite different from the one that existed in 1991 when India’s CAD had breached the 3 per cent level pushing the country into a liquidity crisis. It did not have the comfort of large foreign exchange reserves of nearly $300 billion then as now. Secondly, there is now a much more healthy inflow of FDI and portfolio capital than was there in 1991. To some extent, CAD helps the country absorb net foreign savings such as FDI. Nonetheless, a current account deficit of the order of 3 per cent is not sustainable.

The standard prescription for addressing the challenge of deteriorating CAD would be to promote India’s exports more vigorously. In the present scenario of an uncertain and anaemic recovery of the advanced economies and given the compulsions of unwinding global imbalances and debt-fuelled excessive consumption, however, a major thrust on export promotion has its limitations. The appreciating rupee is also making it even more challenging. While export promotion should be done as much as possible, a somewhat unconventional way out would be to focus on developing new industries leveraging its large and expanding market to substitute and imports while also generating jobs and raising the proportion of manufacturing in the GDP. A few strategic priorities for strengthening India’s BOP situation would include the following:

Leveraging large domestic market for new industries
In 2009-10, India imported nearly $75-80 billion of capital goods-non-electrical machinery and electronic equipment, much of which can be competitively produced in the country now that there is a large domestic demand. In products such as personal computers, LCD panels, solar panels, telecommunication and power generation equipment, but even in commercial aircrafts, ship building and rigs, domestic market size is now able to support world-scale competitive manufacturing units.

Encouraging exporters of equipment to start local manufacturing units by offering pioneer industry incentives and offset programmes is one way out as done by the East Asian countries to generate local value-added and jobs while saving foreign exchange. One lesson from the industrialisation experiences of all major developed and newly industrialising countries is that infant industry protection is critical and has been extensively used by them in the early stages of development. Short-term investment incentives and other protection offered to new industries can prove fruitful as is demonstrated by the rise of mobile handset manufacturing base in the country in recent years.

Exploiting the potential of FDI in retail for export promotion
Another option is to exploit the potential of retail FDI for export expansion. A number of global retailers are interested in exploiting the enormous Indian market and are waiting for the liberalisation of government policy for multi-brand retail. The retail chains, given their global reach and captive marketing networks could be important vehicles for promotion of exports, especially products of SMEs. The government could consider their entry subject to accepting an export obligation rising progressively from 25 per cent to 50 per cent of turnover over five years could push them to mobilise their marketing prowess for promoting exports from India.

Foreign retail giants can assist the Indian SMEs build export capability by providing them product specifications, packaging requirements, and other necessary know how and arranging their logistical and marketing networks. Walmart alone apparently exported over $26 billion worth of merchandise from China to the US. They can also help in India’s evolution as a export hub for SME products generating millions of jobs in that process and thus mitigating the possible loss of jobs in unorganised retailers. Such export obligations are perfectly consistent with the TRIMs and GATS obligations and can be imposed without any complications with WTO rules. They prompt foreign companies to pay attention to exploit their host country’s potential for sourcing, which they otherwise may not exploit.

Frugal innovations for developing new exportable products
India should also identify a few products for developing revolutionary designs giving great value for money, using our globally-recognised “frugal engineering” skills that have led to development of cheapest generic medicines, satellites and their launch vehicles, and indeed the Nano car. These products will have major markets in developing countries around the world besides in India. They could be produced in large volumes and exported to developing countries.

In other words, the time has come for realising the manufacturing potential of India’s manufacturing potential in a big manner for domestic market as well as for exports for finding job opportunities for its teeming millions besides taking care of the vulnerabilities on the balance of payments.

The author is Chief Economist of UN-ESCAP (United Nations Economic and Social Commission for Asia and Pacific), Bangkok. The views expressed here are those of the author and do not necessarily reflect the views of the UN. Comments are welcome at  

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First Published: Tue, March 29 2011. 00:38 IST