The Twin Deficit Trap

Indian economy is in the grip of classic quagmire named twin deficit. Fiscal deficit is already looming large thanks to the acute imbalance of revenue and expenditure. While current account deficit has risen to a precarious level indicating a fragile state of affair at the forex management front. A decadal low growth is making things worse. As stubborn inflation and political fluidity is here to stay, India has become a riskier place for global investors than its emerging market peers.        

A current account deficit occurs when a country’s total import of goods, services and transfers is higher than the total exports of goods, services and transfers. India’s current account deficit (CAD) has peaked to the level of 4.5% of the GDP which denotes that India is importing more and exporting less. This is the highest level of CAD in last 20 years and it is more than 1991, the year when India faced a balance of payments crisis. The skyrocketing CAD is a result of India’s huge foreign trade deficit.  The slowdown in the global economy has taken its toll from India’s exports while imports are rising unabated. Energy import (Crude oil and coal) are the fastest growing imports in last few quarters.

India is also not able to create a favorable investor environment and deters foreign investors to invest in the economy. This is another big drag of forex inflow apart from the skewed export proceeds. This current account deficit puts burden on domestic currency. Rupee has witnessed a fresh onslaught of speculators recently after CAD figure came out to public domain. A current account deficit of about 2% of GDP is sustainable in India which needs foreign funds to propel its growth. But a CAD of 4.5 pc is just a crisis and it is likely to hit rupee further in coming months.

Indian federal budget is perennially in the grip of populist profligacy. The frightening days of high fiscal deficit has returned now.  The Centre's fiscal deficit stood at Rs 3.68 lakh crore in the first seven months of this fiscal, constituting 68.32% of revised target of fiscal deficit for the entire 2012-13. Finance Minister P Chidambaram had earlier revised fiscal deficit target to 5.3% of GDP from the Budget Estimate of 5.1%. Collating GDP figures released today and fiscal deficit figures released last month, fiscal deficit constituted 7.36% of GDP in the first half of 2012-13. Ever major indicator related to fiscal deficit is giving a dismal picture as expenditure on rise and revenue growth has been tapered due to general economic slowdown. Exorbitant subsidies and reckless spending in failed schemes such as MNEREGS is one of the key reasons of fiscal quandary. Government is forced to borrow more from the market to finance its expenditure. Heavy Govt borrowings are crowding out private loans and adding fuel the inflation. The vicious cycle of high fisc def, high govt borrowing, increased money supply, inflation and high interest rates is setting in now.  

Though a minimal amount of fiscal and current account is not bad for the economy but given the present economic environment, it is going to be a deadly deterrent to the prospect of growth.  GDP growth has dipped down to 5.3% in Q2 from 5.5% of the previous quarter. With a below 6pc growth rate twin deficits have become a deadly duo for overall economic management in the nation. A quick correction to the situation seems impossible as India’s unstable political environment is making it further difficult. Indian economy is now venturing in to minefield of uncertainties.  Things will improve only after the political scene becomes clear i.e. after post Loka Sabha elections in 2014.