The latest quarterly data on balance of payments released by the Reserve Bank of India last week, reveal a new development: after six consecutive quarters of surpluses, India recorded a current account deficit of $1.2 billion in the quarter April-June 2003.
Trade deficits are generally considered bad news in India. We have a long history of distress owing to large trade deficits.
Many people have vivid memories of 'shortages' of foreign exchange, and the mere mention of a 'trade deficit' sets alarm bells ringing.
But in the present situation, is this really bad news? How do we interpret this news, and what does it foretell?
In the quest for answers, let us first look at the sources of change in the current account.
Exports grew at 12 per cent in the first quarter. Net invisibles continued to do well: they grew from $3.2 billion in April-June last year to $4.65 billion in the first quarter this year.
What changed, to cause a larger trade deficit, was a sharp rise in imports.
Exports were at $13.5 billion during the first quarter of 2003-04 compared to $12.0 billion in the first quarter last year. This was a decent, though not stellar, performance.
However, imports shot up to $19.4 billion against $14.8 billion during the quarter. With a sharp surge in imports but not in exports, the trade deficit during April-June 2003 widened to $5.85 billion, as against $2.75 billion during the corresponding period of 2002.
Given the net invisibles earnings during April-June 2003 of $4.65 billion, the current account recorded a deficit of $1.2 billion.
A rise in imports might be worrisome when it is caused by external shocks such as a rise in higher oil prices. However, import figures show that during April to August, what really changed were non-oil imports, which rose sharply by 28 per cent.
Commodity-wise imports available till May show that major non-POL (petroleum, oil and lubricants) import items were vegetable oils, yarn and fabrics, medicinal and pharmaceutical products, organic chemicals, electrical machinery, machine tools, non-electrical machinery, electronic goods, gold, iron and steel, manufactures of metals, non-ferrous metals, paper board manufactures, synthetic rubbers and wood and wood products.
Imports of these items were higher in the range of 32-89 per cent. Non-oil imports such as those listed above are leading indicators for growth in industry. They increase when domestic and/or export demand is strong. The sharp rise in non-oil imports over April-August, hence, bodes well for the economy.
The reasons for the increase in the deficit are, therefore, factors that indicate the good health of the Indian economy.
If there was a slump in imports growth, we would be bemoaning it! The second reason why we may argue that the current account deficit is not a bad thing has to do with India's development strategy.
India hopes to attract foreign capital and absorb it, so that the investment in the country is not constrained by the availability of domestic savings. The saving-investment gap is equal to the current account balance.
A current account deficit will be observed when domestic investment exceeds domestic savings. It means India is importing capital.
On the other hand, a current account surplus indicates that India is exporting capital. A current account deficit is thus consistent with India's target of higher investment to achieve 8 per cent growth.
There would be something puzzling about India exporting capital when we wish to invest more.
Unlike the countries of East Asia who may not need to import capital because of their high domestic saving and investment rates, India cannot sustain a policy of exporting capital or current account surpluses, and simultaneously obtain high rates of investment.
This means that while we do want exports to be an engine of growth, the growth in imports has to be even higher.
From the perspective of growth in India, it appears that it would be desirable to run a current account deficit of around 2.5 per cent of the gross domestic product. This would augment domestic savings and serve to improve domestic growth.
The third reason why a current account deficit may, in the present circumstances, be a boon, is because of the implications it has for the problematic inflow of dollars.
Surpluses on the current account have been adding to dollar inflows on the capital account, creating further pressure on the rupee to appreciate. To prevent appreciation of the rupee dollar rate, the RBI has been purchasing dollars and adding to reserves.
Very often these days people ask the question: how can India best use her forex reserves? We periodically hear notions of using reserves to build infrastructure in India.
The best answer lies in precisely how they were 'used' in the first quarter: to pay for a current account deficit resulting from high growth in non-oil imports.
Trade data, for the fuller period of April-August 2003, indicates that export growth slowed down in August.
One of the causes that is immediately attributed to the slowdown is the exchange rate.
However, since the rupee appreciated nominally versus the US dollar, and against East Asian currencies, but not in terms of the REER, it is not easy to say clearly what was the impact of exchange rate changes.
During April-May 2003, exports of four major commodities -- non-basmati rice, cotton yarn, fabrics & made-ups, readymade garments and gems & jewellery -- were down as compared to their exports in April-May 2002.
It may be too soon to say that export growth is on its way down and that the nominal rupee appreciation is responsible for this.
For example, the export of rice is a function both of domestic availability and government restrictions.
Gems and jewellery are value added exports and nominal rupee dollar appreciation impacts both imports and exports. It is not obvious that nominal appreciation would negatively impact exports because imports also become cheaper.
In summary, we should be careful to stay away from the psychology of shortages of hard currency. India is now at a point where we earn hard currency revenues of $100 billion a year -- comprising $55 billion of goods and $45 billion of services.
We need to be clear-headed about this question, and rejoice in a current account deficit.
A current account deficit means that the world is willing to give us goods in return for our securities. We should seek to steadily run up a current account deficit of roughly 2.5 per cent of GDP.
It is important at this juncture that exporters are not allowed to use the bogey of the current account deficit to create a scare and demand that the rupee-dollar rate not be allowed flexibility.
This policy has clearly been counter-productive as it caused speculative inflows into India and added to the upward pressure on the rupee.
If the rupee had been allowed more flexibility during 2002, the capital inflows that have been taking place on the back of the expected appreciation might have been prevented.
These have only added to the pressure on the rupee to appreciate and thus to the woes of exporters.
The author is at ICRIER. These are her personal views