Current Account Deficit - A Real Danger

Current Account Deficit (CAD) is one of the primary components of balance of payments the other being the capital account. The current account deficit is referred to when a country’s total imports is higher than the total exports. Current Account Surplus (CAS) is just the opposite where the exports are higher than the imports. The former of the balance of payment make a country a debtor to the nations which it has trade relationship and the latter a creditor to other nations. Obviously, now you know that a surplus in current account is good and a deficit being really bad for a country. This is one of the important macroeconomic indicators that describe the state of a nation’s Balance of payments (BOP) and foreign exchange reserves. In the age of globalization where each country has a significant and potential role in international trade and finance, this indicator is crucial in understanding a nation’s foreign exchange reserve and trade account.

India entered into the globalized world in 1991 with the effect of New Economic Policy. The new economic reform was initiated by the then finance minister Dr. Manmohan Singh which helped India to come out of a serious Balance of Payment (BOP) crisis. The policy was and is still considered as a milestone in the history of Indian economic reform. The reform not only saved India from a severe bop that was threatening but also paved way to a new world of globalization. The important concept under the new economic policy was liberalization, privatization and globalization what came to be shortly known as LPG. hat came to be shortly known as LPG.economic policy was liberalization, privitization n indian economic reformme out a serious Before 1991 India had many restrictive trade barriers and did not support much trade related activities. The policy introduced liberalization which freed those trade barriers and encouraged world trade and practices. India by signing General Agreement on Trade and Tariff (GATT) soon became an emerging global hub of international trade. Privatization is encouraging private players. Many public sector companies were changed partially to private sector and India started encouraging many private sectors entering into the playing field. Globalization is the result of liberalization and privatization. India opened its hands to the global world encouraging international trade and foreign investment like Foreign Direct Investment (FDI) and Foreign Institutional Investment (FII).

The highlights of the policy were noteworthy and significant in the development of India in many aspects. Prime Minister Manmohan Singh being an economist exactly knew where the economy was heading and the dangers in the long run and thus with much thought would have introduced the new economic policy. The policy was applauded by many industrialists and people from both within and opposite party. But the same man now has no idea of what is happening to our economy, maybe, he knows but sitting ideally with no option than listen to what Sonia Gandhi has got to say. Though this may sound rude to some who are in favor of politics but this is the case in the past few years. For those who have a high regard of the Indian political and administration system, the so called “Indian patriotism” I would like to tell that its not the defensive trait you have within you that supports the system but it’s the feeling of what others think about India, which is not nationalism but narcissism. Then why a man with such great caliber was able to save the economy from a crisis in 1991 but not now? The point to be noted here is he saved our country when he was a finance minister but now being a prime minister which means he has more power and experience couldn’t do anything much to save the economy from a brink of a crisis. Of course, I understand that our economy has undergone several structural changes and India now is not the same India when it was in 1991. And thus the same old tonic cannot be offered now to save the economy. Moreover now its even more difficult as we are exposed to global shocks and crisis. But there must sure be a way to solve the present problems whatever may be the situation but the only thing I am concerned and trying to reiterate here is that every day we have been seeing new problems but the existing old problems being untouched or even ignored. One of the serious problem India is facing today is the ballooning CAD. Though our economy has grown leaps and bounds since 1991 it is the same problem we face today that we faced in 1991. The high CAD is of a big concern and finance minister and other government officials have been making statements to reduce it  if not at least control it. What are the steps they have taken in this regard? Do they seem to be efficient and produce the desired results?

The Current Account Deficit (CAD) touched a record high of 6.7 percent of Gross Domestic Product (GDP) in the third quarter of the last fiscal (October-December).  This created panic among some individuals but the policymakers seem to be not surprised by the figure because in the past few months all economic indicators have pointed to rise continuously, though the magnitude have been beyond imagination. Holding this upward trend there have also been poor policy responses to meet the problems. The finance minister said and promised to bring the CAD to 4.8 percent of GDP by the end of this fiscal which is still high but not alarming. The CAD has been funded through capital inflows and not through the foreign reserves which is a good sign. Infact in last few months there have also been increase in the reserves. Though this is good to hear the CAD is still high which is really unacceptable and much beyond actual RBI forecast of 3 percent of GDP. No wonder this high CAD has seldom caused so much concern. Another way to calculate the CAD is the merchandise trade deficit plus or minus invisibles from net earnings from services. The primary reason for the widening CAD is the large merchandise trade deficit. The large imports of oil, gold and silver have been the main contributor. Since the global crisis the exports have been constant or sometimes declining but the merchandise imports continue to increase sharply. The lackluster performance of the net receipts and net invisibles has helped the balance of payments but has added to the pressures. The dependence on short term capital flows to bridge the gap and finance the CAD is dangerous. According to RBI, the pickup in capital inflows was mainly due to foreign portfolio investments. Foreign direct investment, by far the most desirable investment flows declined in the third quarter of previous fiscal. The government has been taking several strategy based policy decisions that could help the environment conducive for short term capital flows. The finance minister in the last few months has asked the people of India to control their passion for gold. He raised the import duty of gold in the last budget to reduce the demand of the yellow metal which has been the main component in widening the CAD. The fall in gold and commodity prices will reduce the current account deficit but they are not the real solution. He has planned to introduce Inflation Indexed Bond (IIB) in this fiscal year to curb the demand for gold and encourage investments that could well be used as a hedge against inflation.  He also encouraged investors to invest in mutual funds by raising the limit through Rajiv Gandhi Equity Savings Scheme. The following graph shows the CAD, export and import as a percentage of GDP in the last thirteen years.

Anyway it is the job of the finance minister to hold out hope. The marginal propensity to import by borrowing money in India is small. People borrow more money when the interest rates are low and they then spend. Some of the extra spending gets translated into imports. Without imports, the extra demand would get translated into higher prices. India being India, we have both inflation and higher imports. And add to lower exports and what we have is something very worrying, a looming balance of payments crisis. Government should control fiscal deficit no matter what the goals are, to achieve long term sustainability. The big bang reforms of 1991 happened because the government then was much more tempted by short term political pay offs rather than long term sustainability. The current set of reforms is also happening because a crisis is looming. A revival in exports depends on the economic conditions in USA and Europe. There is not much India can do about it. But financial incentives for export promotion can help in a long way to reverse and improve the scenario. In the 22 years since the last major crisis, the economy is right back where it started. One should know that two decades ago, Manmohan Singh started off by getting the economy out of a very deep trouble. Now he seems to end his career by landing it right back into it. 

Gold - The shining yellow metal

Gold in India apart from being seen as a traditional and luxurious good has always been considered as one of the best investment option. This yellow metal particularly has gained attention and interest in recent times since the global recession. As our country is facing high inflation and people are constantly fighting the inflationary pressure, gold seems to be the best investment option that stands as a hedge against inflation. Over the years, particularly in the last five years people in India have become increasingly obsessed with the yellow metal. India is the largest consumer of gold. Gold has always been considered as a significant commodity since early age. Before money came into existence, people those days had gold as their reserve for all the transactions. The evolution of money came from the barter system and the gold standard system. The barter system is where people exchanged goods for transaction. With its limitations, then came the gold standard where gold coins and paper were minted and used for all the transactions. With its limitations came the currency paper system that we use today. Many kings valued gold both in terms of monetary and investment. Thus gold holds a significant importance in history. Today, gold is a long term store of value for governments and individuals. One cannot forget gold when talking about the evolution of money.

Gold of all the other precious metals is the most popular investment choice of the retail investors. What is there in this metal that lures people? Generally people follow an option that attracts everyone. In this case the demand for gold has always been high and that is why many are enticed to invest in this precious metal. The demand for gold is always on the rise making it more valuable and attractive. This is one of the primary reasons for the soaring price of the metal. The other is the demand supply mismatch that causes the price to fluctuate rapidly. The supply of gold in general is limited as the cost of production is very high and globally gold bullions are limited resources. Like all the other markets, gold market is also subjected to speculation and fluctuation. There is a plethora of various investment platforms and this raises the uncertainty and speculative nature of each investment option. A good investment should give high return or at least expected return so that we don’t go in losing our money. The risk associated with each of these investment options out there varies according to the market in which they are traded. Out of all these the stock markets namely the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) in India is more volatile. The stock market is a place where equity shares of companies are bought and sold by buyers and sellers. In an inflationary situation or the economy facing a crisis this is the first market that is bound to get affected greatly because of slower economic growth and capital investment. During recession bank deposits also don’t give you high returns but moderate assured returns.  In a situation like this gold investment is better as it yields good profit and value for your money. So a careful analysis of the market condition and macroeconomic indicators should be carried out in order to choose and invest in the most rewarding investment platform. The factors surrounding gold as a best investment option against a falling economy is not clear for many first time gold buyers.

Gold is more commercial than stocks as gold is easy to buy and sell. Many countries across the world have gold as reserve as its easily convertible into cash. Gold investments have become easy now with wide avenues open to trade the metal. Thanks to internet now buyers and sellers can bargain and negotiate on gold prices and use it as a platform to promote gold stock. In the present economic situation with weaker economic growth, persistent high inflation and financial uncertainty gold is easy to liquidate as well. Even during recession, gold by many is considered as a fashion statement and thus increasing the demand and the jewelry business. But once if you consider investing in gold have the patience and be prepared to wait for good returns that are viable only in the long run. The more years you hold gold the better returns you get. Gold can be easily sold in times of emergency. Since gold is an asset class it is considered as wealth insurance. So unlike other investments like stocks and real estate, investment in gold does not value timing. Before deciding on to invest in gold one should know which form of gold to buy to make it for a better investment because gold can be bought in many ways. Indians mostly buy gold as jewelry and ornaments but this is not the right choice for gold as a investment since jewelry  is just a personal belonging for adornment  and does not guarantee you assured returns when sold. So gold like bars and biscuits is a better form of investment than jewelry as they are in the purest form. Of all, the one that is gaining popular in recent times is the gold Exchange Traded Funds (ETFs). These are just like mutual funds held in paper form in your demat account. This form of gold investment offers better option as it is easy to transact.

The recent drop in the gold prices signaled caution and speculation across the world shaking investor confidence. Does this signal the lust for gold is coming to an end? Does gold started losing its shine? What caused the international gold price to fall suddenly? First, it is not the demand for gold jewelry but gold investment that spurred the prices of gold to escalate since 2000. Historically, gold has been the safest investment. The demand for gold biscuits and ETFs doubled between 2005 and 2012. The main reason for this increase in demand for gold as an investment is because of the globalization of world economies. Since the 21^st millennium many emerging nations across the world due to globalization entered into the growth phase that caused inflation to move higher making investors to buy gold as a hedge against financial instability. Since 2003 the dollar value has been on decline helping the gold price to sky rocket. This sharp increase in gold prices attracted investment funds in search of high yielding assets, fuelling the price increase. So many investment and hedge fund companies started taking a leveraged bet on prices through futures trading. Commodity trading seems to be risky but the most rewardable of all the other investment options. A classic example was the rise in the crude oil prices in 2008. Data suggests that there is a strong correlation between prices of gold and crude oil.  The continuous surge in the international gold prices peaked since 2003. However, the international gold prices started declining gradually since the financial crisis of 2008. Many investment fund managers and small investors started losing interest in the asset that is declining or trending sideways. The decrease in the gold price internationally made investors to doubt the returns of the asset. Evidently, this decrease delivered very low return of just 5 to 10 percent in 2011 and 2012 compared to high returns since 2001. Thus many investors and fund managers are parting with the gold holdings. World gold council data reflects that the investment in gold has been declining in the past two years. The sudden plunge in the gold prices is also because of the gloomy situation prevailing in the Eurozone. Cyprus is the latest to join the league of default in the euro crisis. The banks in Cyprus were shut down because it went bankrupt of inadequate liquidity. Cyprus started to pay its debt through its gold reserve that made the gold price to fall dramatically.

The fall in the prices of gold came as a rude shock to some of the investors who thought they were playing with the safest bet. The question that ponders many investors is that whether this fall is permanent? No, because nothing in the business and investment world can be permanent. And there are many factors that are still supportive of gold prices. The gold jewelry business is bound to see profits as the demand for gold jewelry is to rise with the price decline. Many jewelers say that the fall in the gold price is just seasonal and temporary and expected to see the value of gold to increase again by later this year. Inflation continues to be a concern in most emerging economies like India and the depreciating value of rupee will make many investors park at least part of their money in gold or gold backed assets. The government and central banks will also have to continue increase in their gold holdings against the risk from a weaker dollar and euro. Investors can still look on gold for investment as it still seems to be an alluring investment option. Any asset that has trended in only one direction for years is bound to decline. Seen in this context, the recent decline in the gold price may be healthy. The banking sector and the stock market globally have become weaker and are prone to uncertainty prevailing around the global economy. In such a situation the demand for gold is expected to be strong. Keynes has acknowledged that “gold has become part of the apparatus of conservatism and is one of the matters which we cannot expect to see handled without prejudice.” The gold purchase will be high this month during the Akshaya Tritya as it is believed that investment made on this day tend to appreciate and continue to grow.  

The aftermath of the global crisis

The financial crisis and the European Union sovereign debt crisis is the greatest economic crisis in recent times. Ordinary people still don’t seem to understand the nuances of the ongoing economic crisis but all the people around the world are affected by the crisis. No wonder even some great economists and policymakers are as perplexed as us about the crisis. They are scratching their head with ideas to bring the global economy on track. The crisis has serious consequences and implications across the globe but the degree to which each country is affected varies considering their respective domestic and geopolitical factors. In the age of globalization no nation can keep aloof from the world economic volatility. In this article I would like to tell how some key economies in the world are performing post the global financial crisis.

Now we know that the global financial crisis started in the USA and reached across various countries and the sovereign debt crisis is because of the huge amount of debt created by the European Union countries. Both USA and countries in Europe are highly developed countries and hold the tag of developed nations for a very long time now. Over the years both the United States of America and some countries in Europe were developing robustly losing track on their debt levels. Data shows that both the USA and Europe’s debt level is always on the rise and the countries got well acquainted with the industrial revolution. The capitalistic nature of these developed countries is the main reason for the crisis to take place. The capitalism system of an economy was carefully analyzed by three great economists who are pioneers in introducing economic theories that stand out to be important in their own way. The ideas proposed by these economists are unique in their own way and are still relevant in present day.  The three economists I am talking about here are Adam Smith, Karl Marx and John Maynard Keynes. Economics is a field that gives freedom of thought and expression to its practitioners and so does there exists two groups namely conservative and non-conservative group. Adam smith in his book ‘The wealth of nations’ (1766) explained about capitalism and its functions. He introduced the concept of division of labor which means specialization of individuals in performing specific tasks and roles for efficient production. He viewed that the capitalistic economy works on invisible hand i.e free market which means that the market is able to achieve equilibrium on its own through demand and supply forces. Karl Marx denied some of the views expressed by Adam smith and gave importance to the concept of laissez faire which strongly opposed government intervention. Keynes is the pioneer in bringing a whole new view to the capitalistic nature of an economy. The great depression of 1930 that affected the US economy was saved from the theories introduced by Keynes in his masterpiece book ‘The general theory of employment, interest and money’ (1936). Since then the world has been following his theories and most of the present economists are post Keynesians. Thus John Maynard Keynes came to be known as the “Father of modern macroeconomics”.

China is said to be the next superpower of the world after the USA. Many experts believe that china’s exports will outgrow that of the USA by 2016. The Chinese economy is the forerunner in the Asian market followed by India. China has been showing good trend post the financial crisis with GDP growth above 7 percent. This is mainly because of good policy reforms and monetary transmission. The high growth that china witnessed in 2009 was because of structural reforms. The Chinese government responded swiftly to the global crisis by introducing 4 trillion Yuan stimulus package. The country’s central bank cut interest rates deeply thus encouraging the growth of credit.  Since the crisis in 2008 the Chinese government has been faced with three major tasks which are crisis management, structural adjustments and protecting its foreign exchange reserves. The stimulus package is the result of expansionary fiscal policy where the government increased its expenditure and reduced tax rate thus raising the real disposable income of its people. Most of the money from the package was spent on infrastructure. But many private investors especially small and medium sized enterprises did not benefit much from the spending binge. Many local governments are squeezing their small enterprises to compensate for the reduction in their fiscal revenue resulting from the slowdown in economic growth. The scope of the Chinese government to implement the fiscal stimulus was very high because of the country’s strong fiscal position, vast domestic market and strong external position. One of the important feature of the china’s stimulus plan is the large amount of tax rebates for exports. In contrast to many other developing countries, china has a strong point and is sustainable to carry out a expansionary fiscal policy. This is because over the past decade china has a very low budget deficit to GDP ratio. However, such expansionary fiscal policy for a long time is dangerous and can even produce negative results. This is evident from the sluggish economic growth from the beginning of 2013. The growth in the beginning of the year was driven mainly by exports and real estate. The housing bubble of the us financial crisis did have an impact on the Chinese economy but their government encouraged domestic real estate producers by making availability of credit easier. The current trajectory can be sustained only by pumping more leverage into the system. Though china boasts of its exports, it has a weak consumption demand. Almost all the core sectors of the economy like clothes, auto and food is greatly affected. Some economists in china warn that pumping in more money into the system might help china to achieve its official growth target of 7.5 percent but only at the expense of financial risk.

Initially the global financial crisis did not adversely affect the Indian economy. But later it did take a toll on the economy. The country registered a high growth rate of above 7 percent in 2009. The Indian economy continues to grow because of ample demand. During 2008 India’s rural consumption generated enough demand to substantially insulate India from global trade shocks. Thelate india from global trade shocks.ause of ample demand.nd  India also witnessed high growth soon after the economic crisis because of its expansionary fiscal policy. India, like china introduced huge fiscal stimulus packages to revive the economy and protect the economy from the global recession. Since the global crisis caused some of the leading banks to go bankrupt, the entire financial system including India was affected no matter how strong the country’s financial market was before the crisis. However, the banks in India have managed quite well even after the financial crisis and this is because of the strict monetary policy suit of the Reserve Bank of India post the crisis. Though the stimulus package helped in creating a high growth of 8 percent eventually it resulted in an inflationary situation. The high government expenditure post the crisis resulted in a high budget deficit. The country’s monetary transmission needs to really appreciated as it has been stringent but effective. Of late the central bank of India have been taking number of monetary easing and liquidity enhancing position to facilitate flow of funds from the financial system to meet the needs of the productive sectors. One serious problem most of the banks in India have been facing after the financial crisis is the rise in Non Performing Assets (NPA) which is because of weak economic growth and low capital investment. Unfortunately it is the mismanagement in the fiscal policy that has resulted in various serious problems like persistent high inflation, slow economic growth, low consumption and investment demand and huge trade deficit and Current Account Deficit (CAD). There is a constant battle between the central government and the RBI in controlling the trade off between growth and inflation resulting in ping pong economics. From the beginning of 2012 there has been a huge mismatch between production, consumption, saving and investment which is the primary cause for the current economic instability. The impact of the financial crisis is great in portfolio equity flows and liquidity position of the country. At present India is facing difficulties in fostering its regional and global interests.  The global financial turmoil has widely affected the Indian service sector as it holds a significant position in the global economy. Since the financial meltdown has affected the country’s foreign exchange reserves due to outflow of short term capital, the rupee value has been depreciating which is of a serious concern.  RBI has decided to bring in more private players in the banking sector which would help in financial inclusion and better investment scenario.

Many other developing countries apart from India and china have been growing strongly but forecasts have been negative in the past few months. However, the world economic outlook released by the International Monetary Fund (IMF) last month has projected a positive global economic growth. The crisis is becoming severe and the magnitude of the crisis will depend on the response of USA and EU. Many developed nations is already entering into a severe recessionary phase. The financial crisis has affected the developing countries in two ways. First, there has been immense financial contagion in emerging markets. Second, pressures on trade and foreign investments. Developing countries because of the trade imbalances face huge current account deficit and are feeling the pressures on exchange rates and interest rates. The developed nations suffer serious fall in unemployment compared to developing nations. Both the developing and developed countries not only suffer economic problems but all also social problems like lower growth translating into poverty in emerging nations and social unrest in the developed world and more crime, weaker health systems and even more difficulties meeting the Millennium Development Goals. Thus the current macroeconomic and social challenges posed by the global financial crisis require a much better understanding of appropriate and effective policy responses to save the world from another serious economic collapse.

Beware the nostrums of economists

Beware the nostrums of economists - The Hindu