Economy Jan 2, 2013
India's record current account deficit is "worrying," Finance Minister P Chidambaram said on Wednesday, and hinted at cutting gold imports to bolster weak external accounts that have brought back memories of a 1991 currency crisis.
Data on Monday showed the deficit widened to 5.4 percent of gross domestic product (GDP) in the September quarter, driven by falling exports. The gap, the widest in absolute terms since 1949, has weakened the rupee currency and exposed the economy to costlier imports. "While the CAD is indeed worrying, I think it is within our capacity to finance," Chidambaram told reporters, referring to the current account deficit.
He said he was considering reining in imports of gold, used as an investment tool by Indians but which mean a drain on foreign currency reserves. "We may be left with no choice but to make it a little more expensive to import gold," Chidambaram said. He however, declined to elaborate.
The government could increase the import duty on gold by 1-2 percentage points, though no decision had been taken, a senior finance ministry official told Reuters. In 1991, the current account deficit hit 3 percent of GDP and India came within weeks of running out of foreign currency. It was forced to airlift some gold stocks to Europe to secure loans, a humiliating situation that helped bring down a government and usher in free market reforms.
This time, the economy is far bigger and more open, and Chidambaram said foreign investment flows should be able to finance the deficit without drawing on hard currency reserves of $296.5 billion, enough for about seven months of imports. Even so, worries over India's external accounts, borrowing and fiscal deficit have led global ratings agencies Standard & Poors and Fitch to threaten downgrading its credit to junk.
Faced with the prospect of fighting elections in 2014 on the back of the weakest economic growth in a decade, high inflation and a possible sovereign downgrade, in September, Prime Minister Manmohan Singh - a veteran economist who oversaw the 1991 reforms - launched controversial new measures to free up the economy, including inviting investment from foreign supermarkets.
"I would like to once again underscore the crucial importance of FDI and FII," Chidambaram said, referring to foreign direct investment and foreign institutional investment. "As I have said before, attracting foreign funds to India has become an economic imperative."
Since September, the government has raised limits on how much corporate and government debt foreign investors buy, but the widening deficit has faced headwinds from expensive oil, high gold imports and a sharp drop in exports. Chidambaram said gold imports at $20.25 billion substantially contributed to the widening of the current account deficit - $38.7 billion or 4.6 percent of GDP in the first six months of the current fiscal year ending in March.
"Suppose gold imports had been one half of the actual level, that would have meant our foreign exchange reserves would have increased by $10.5 billion," he said.
In the April-November period, India's total exports contracted by nearly 6 percent from a year earlier, leaving a trade deficit of nearly $130 billion. Worried by the ballooning deficit, the government in March doubled the import duty on gold to 4 percent. Gold is the biggest contributor to the import bill after crude oil and is easier to tame than energy supplies.
Chidambaram said he expected gold imports to touch $40 billion in the current fiscal year to end-March, down 31 percent from the year-ago bill of $58 billion. "As it is demand is lower and this could dent demand for gold further," said Gnanasekar Thiagarajan, director of Commtrendz Research in Mumbai.
Recently, Reserve Bank of India executive Director Deepak Mohanty urged investors to shift from physical gold as a hedge against rising prices to financial products like inflation-linked bonds.
India's gold imports rose 9 percent to 223.1 tonnes in the September quarter, after a 56 percent fall in the June quarter to 131 tonnes. Analysts predict a recovery in the December quarter due to peak festival- and wedding-season buying.
More From Firstbiz Staff.