Deficit dilemma

The Budget for 2011-12 has drawn a lot of praise. The stock market, after some initial doubts, has also responded positively. However, there is one aspect which it has tried to brazen its way through — the high current account deficit (CAD). This is the difference between what India earns from its exports and what it pays for its imports. There have always been divergent views over what constitutes a sustainable level for the CAD. Expressed as a percentage of GDP, should it be 2.5, 3 or 3.5 per cent? It is useful in this regard to note what the Prime Minister's Economic Advisory Council (PMEAC) has recently said. To quote, “...sustaining such high levels of Current Account Deficit on a regular basis is neither possible nor indeed desirable... It is likely that in 2011/12 the CAD may be at 2.8 per cent of GDP. However, even this is on the higher side.” At the same time, it has also said that “In order to be able to finance these large deficits in a manner that does not stress the external payment account... the focus must be on facilitating such capital inflows.”

The Budget has taken note of the latter advice but it is not clear what its views are on the former. As with all gaps between earnings and expenditures, the real issue is how such gaps are financed. If exports are booming and the expectation is that they will continue to do so, a country can risk a larger deficit. But if there is some doubt on this score, it is prudent to stay with a lower deficit by reducing imports, rather than financing the higher deficit through debt. For 2011-12, if the Indian economy is to grow at 9 percent, the gap will be closer to 4 per cent rather than 3 per cent. It certainly will not be less than 3 per cent. Fully aware of this, the Budget has chosen to rely on capital inflows from two non-debt sources: FIIs, which can now invest up to $40 billion in corporate bonds, of which $25 billion have to be in bonds issued by infrastructure companies with a five-year lock in; and individuals who can invest in Indian mutual funds, provided they meet the KYC norms. The former seems unlikely because no FII likes lock-ins; and the latter will succeed mainly for NRIs who may bring in a billion or two dollars. So to the extent that the 9 per cent growth projection is predicated on a certain level of industrial production which requires foreign savings coming to the rescue of the investment gap, there is a question mark and a dilemma.

The question is whether the inflows will come in; the dilemma is, if they do come in, not only will they add to money supply and inflation, but also, later on, to repayments. So, as so many other countries have discovered, India is between a rock and hard place as it strives to fulfil the Prime Minister's dream of touching double-digit growth during his term in office.

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