India's macroeconomic future hangs in the balance. Its current account deficit narrowed to $5.2bn, or 1.2% of gross domestic product, during the second quarter ending September 30, down from a $21bn deficit year-on-year, the Reserve Bank of India said on December 2. The figure is much lower than the 4.9% of GDP deficit the country reported for the first quarter of fiscal 2013.
But on the other hand, between April and October the fiscal deficit stood at 84.4% of the amount set as an annual target by the government during its budget meeting — a rise from the 71% during the same period last year. There is a fear that, if this trend continues, India will fail to contain the deficit at its target of 4.8% of GDP.
If the target is not met, the list of problems that will follow is long, especially as the country has already seen huge outflows. For example, net portfolio investments saw an outflow of $6.6bn for the quarter, while equities, debt and primary income also lost billions — trumping figures from the previous quarter.
There is also pressure from the fact that all the international ratings agencies are closely watching India’s developments, and will waste no time in downgrading the country’s investment grade status to junk if the need arises.
Standard & Poor’s in November affirmed its BBB- rating of India with a negative outlook, and said it will not review its position until the general elections next year, unless there is an unexpected drop in fiscal or external accounts.
For now, though, the Indian economy is better placed than where it was six months ago. The sight of the rupee going into freefall in the summer, falling to a low of Rs68.84 against the dollar in August, acted as a wake-up call to policymakers, who brought in tough measures to curb volatility.
These included opening up the market to more foreign direct investment, and providing opportunities to companies to shore up on their dollar reserves.
The hard work is now starting to pay off. Not only has the current account deficit shrunk considerably, but FDI worth $7bn came in during the second quarter. Added to that, external commercial borrowing in the form of loans jumped by 8.8% to $1.3bn. This was thanks to a short-term concessional swap window opened by the RBI to encourage borrowers to go offshore for dollar funding.
None of this takes away from the dangers posed by the fiscal deficit. There are measures that can be put in place — such as raising taxes and speeding up plans to divest stakes in state-owned companies — but they are unlikely to gain much traction for the moment. A general election are scheduled for the first half of 2014.
One solution that is likely to work, and has been tried before, is cutting expenditure. Analysts point to the middle of last year, when finance minister Palaniappan Chidambaram slashed government expenditure by roughly $15bn to ensure the country stuck to its fiscal deficit target of 5.2%. At the end March, the deficit stood at 4.9%.
Such a move is not a panacea, and fresh expenditure cuts have not yet been announced. But it will bode well for the country in the longer run if the government imposes similar measures this year.
No matter what happens, though, India is in a much stronger position that it was in the summer. Barring a disaster, US tapering is likely to take place next year, again putting pressure on the country’s economy. But it has shouldered the worst already and in the process has managed to address its problems and build a stronger financial footing. If tested again, it will not crumble.