India warns about balance of payments

The Reserve Bank of India warned on Tuesday that volatile capital flows threatened to increase pressure on the country’s balance of payments, which is recording the widest current account deficit among large emerging economies.

Analysts identify the current account deficit – which will put downward pressure on the Indian rupee – alongside double-digit inflation as the biggest challenges for the Indian economy.

India’s current account deficit has widened in the past year as fast-paced economic growth drives greater demand for imported goods, and is forecast to grow larger in the year ahead.

The Reserve Bank of India said on Tuesday that the country’s current account deficit had grown to 2.9 per cent in 2009-10 from 2.4 per cent in the previous year. One reason, the central bank said, for the deterioration in the balance of payments was a decline in an “invisibles surplus”, caused in part by falling revenues to India’s prized outsourcing sector.

Subir Gokarn, the deputy governor of the RBI, said he detected risks with global capital flow volatility. He said there had been “a sharp change in the global scenario with a flight to safety [resulting in capital] exiting from Indian and other emerging markets, which put some pressure on what looks like a comfortable balance of payments.”

Current account balance

India’s current account deficit, the largest among Bric countries, could hit 3 per cent in the coming months to extend the widest margin for three decades.

Although India is unlikely to face difficulties financing its current account deficit provided one of the fastest growing large economies attracts capital inflows, some senior policymakers have urged action to reduce the deficit.

They warn that although the Indian economy is forecast to grow at 8.5 per cent this year, it is imprudent to widen the deficit at a time of global economic uncertainty and financial volatility.

“A higher current account deficit led to a stronger absorption of foreign capital,” the RBI acknowledged in a statement at the release of its annual report for 2009-10.

India’s own foreign exchange reserves, a cushion against volatile capital flows, have fallen over recent months to $278bn from a high of $315bn in May 2008.

Shyamala Gopinath, another RBI deputy governor, told the Financial Times the central bank did not have a target “comfort range” for its foreign reserves but that an internationally recognised yardstick was one year’s cover for imports.

A current account deficit occurs when a country's imports of goods and services is greater than its exports of goods, services and transfers. A wide current account deficit is not necessarily a bad thing for a fast-growing developing country provided that it is attempting to boost local productivity and exports.

Brazil’s current account deficit has widened to $43.76bn, or about 2.24 per cent of GDP, on strong demand for imports. Data released this week showed that Brazil had also suffered a steep fall in foreign exchange inflows.

China and Russia, by comparison, both run current account surpluses.

The RBI on Tuesday issued a cautious assessment of the global economy, observing that uncertainty had deepened in the US and Europe in recent months and the economic recovery was in danger of faltering.

“Capital flows in the initial months of 2010-11 moderated somewhat, reflecting the drop in appetite of global investors in response to the sovereign risk concerns in the eurozone,” it said. “Given the stronger growth outlook of India and the probability of monetary exit being delayed by the advanced economies, capital flows could be expected to accelerate, which will have to managed.”

Earlier this week, Anand Sharma, the commerce minister, warned of the difficulties faced by India’s exporters, describing them as “not out of the woods” of the global financial crisis.

To boost export performance, Mr Sharma announced a raft of export incentives to help garment, leather and handicraft sectors, worth about $225m.