Modern designer–inventor R. Buckminster Fuller once remarked “If you are in a shipwreck and all the boats are gone, a piano top buoyant enough to keep you afloat makes a fortuitous life preserver.” However, just as the best way to design a life preserver is not in the form of a piano top, the best way of having a robust and resilient Current Account is not hoping and praying for lower energy and gold prices. In our last edition of Connecting the Dots – India’s Stealth Game Changer we highlighted how lower energy prices could be India’s stealth game changer. We said that India’s economic turnaround may already have begun thanks to developments in shale oil and gas in the US and lower coal consumption in China. While we do think that India is on course for a turnaround, it is pertinent to appreciate some of the unique aspects of India’s Current Account Deficit (CAD), and understand the vulnerability.
At $93bn, India’s CAD in 2012 was second only to the US in absolute terms, and higher than the UK, Canada and France (Display 1). Even if we assume lower energy prices will result in a saving of about $20bn in the current fiscal year, India still needs to fund its CAD of over $70bn from capital flows. Foreign investments, in the form of FDI and portfolio flows (FII) have been funding $40-50bn of the CAD for five out of the last six years. The notable exception was during the global financial crisis when foreign investment was only $8bn. As the Finance Minister said in his budget speech “Investment is an act of faith”. We surely need foreign investors (FDI plus FII) to demonstrate their faith in the Indian markets by infusing at least $40bn every year. [1]
Source: IMF, Morgan Stanley Research
The other aspect of capital flows is the rising dependence on loans, particularly in the form of short-term trade credit to India. The total amount of debt that will likely come up for redemption or refinancing in the current year is about $165bn, which is about $20bn higher than last year. Even if we assume that $55bn of NRI deposits will be renewed, as they usually do, the balance $110bn is still a large amount of debt that needs to be rolled over or refinanced. [2] A part of the trade credit may relate to a higher oil import bill and may reverse partially as oil prices come off. So, while we are not trying to ring alarm bells here, we think it is important to not take the eye off the ball and focus on improving energy self sufficiency.
Net oil and coal imports constitute 7.5%of India’s GDP, and account for almost 70% of India’s trade deficit. [3] India has done little to adequately address energy self-sufficiency. After declining for almost 20 years until 2005, US energy self-sufficiency has gone up from 69% to 80%. In contrast, India’s energy self sufficiency has been falling from 90% in 1984 to 63% in 2011 (Display 2). Despite having the fifth largest coal reserves in the world, India’s coal imports this year may rise to 130mn tons, up 50% from two years ago. [4]
Source: BP, MSIM Research
Note: Includes energy from Hydro and Nuclear sources, Coal, Gas and Oil
The addiction to imported energy has been one of the key drivers of a deteriorating CAD for India. A widening CAD is typically associated with an overheated economy. When the economy grows beyond its natural limits, it has to increase its reliance on imports, often leading to a higher CAD. In contrast, India’s CAD widened while its growth slowed. CAD increased from about 1% of GDP in 2006 to over 5% of GDP in 2012. This suggests that imports have been quite inelastic to growth changes with increase in gold and energy imports being the key contributors. Display 3 shows the current account balances (deficit and surplus) of countries across the world has narrowed from 2006 to 2012 as global growth slowed down. India has been an outlier here where the CAD has widened, rather than tightened as seen in the rest of the world.
Source: IMF, World Economic Outlook Database, April 2013
Note: Current Account data for 2006 and 2012 has been taken for countries with GDP more than $100 bn. For better visual representation the chart has been truncated to +/- 12% of GDP. Special thanks to Dhananjay Sinha of Emkay Securities.
Seen from the lens of a country’s Savings and Investments, CAD is nothing but Investment minus domestic Savings. So, if a country is Investing more than it is Saving, it results in a deficit in its Current Account. If CAD widens, it normally means that either the Savings are falling or Investments are rising. And that is where the Indian story again is different. In India the CAD is growing with falling Investments, because Savings have been falling at an even faster pace. From F2008 to F2013 the Savings rate has fallen from 36.8% to 29.6% while investments fell from 38.1% to 34.7% over the same period. [5] So while one would have assumed that falling investments of the magnitude of 3.4% would translate into a narrower CAD, the faster fall in savings rate of 7.2% explains it’s widening. As we illustrated in Connecting the Dots – Vulnerability the cyclical component of India’s savings rate i.e. savings excluding Households has come under severe stress after the financial crisis. This needs to improve through reining in of the fiscal deficit and better corporate savings.
The overall situation reminds us of our college days when having whiled away the entire year, we used to burn the midnight oil before the examination. On one such occasion, we got to know the night before, that the exam has been postponed for a couple of weeks. The current reprieve for India, is exactly that. Being the responsible eighteen year olds that we were, we launched into another round of merrymaking, only to be faced with the same crisis two weeks later. For everybody’s sake, we hope India behaves differently.
References:
[1] Retrieved from http://indiabudget.nic.in
[2] Ministry of Finance, Government of India and Reserve Bank of India
[3] RBI, Morgan Stanley Research
[4] Macquarie Research
[5] CSO, RBI, Morgan Stanley Research
Amay Hattangadi and Swanand Kelkar are portfolio managers with Morgan Stanley Investment Management.
This article was originally published by Morgan Stanley, here, and is republished with permission from Amay Hattangadi.
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