Over the weekend, the
government finally signalled its intent to defend the rupee. It announced several steps to prop up capital inflows and to curb “non-essential” imports. It emphasized that it will stick to its fiscal deficit targets. At the same time, it said the Indian economy was on a sound footing and there was no reason to panic.
Almost everybody acknowledges that India’s external vulnerabilities are now lower than what they were during
the taper tantrum in 2013. We may, however, be missing the markedly different external environment. In 2013, the nervousness in the currency markets was because the US Federal Reserve had said it would start to wind down its quantitative easing programme.
At that time, liquidity was still being created, all that was proposed was to taper it. This time around,
the Fed is doing “quantitative tightening” by allowing a steadily increasing amount of its bond holdings to mature each month without being reinvested, shrinking its balance sheet in the process. This has coincided with the US treasury mopping up dollar liquidity by issuing bonds to finance the expanding US fiscal deficit.
That’s not all. The external environment is far worse now than in 2013, with
trade wars rampant, a
reworking of trade treaties, heightened geopolitical tensions and
an uncertain future for the WTO. It would be best, therefore, not to underestimate the possibility of a rapid deterioration of the external environment, which could make it a challenge to fund the current account deficit.
To be sure, the silver lining is that Brent crude prices were above $100 a barrel in 2013, much higher than where they are today. On the other hand, as Chart 1 shows, India’s non-oil trade deficit has gone up by leaps and bounds. It is this deficit the government hopes to reduce by targeting “non-essential imports”.
What is the scope for reducing non-essential imports? For the June quarter, oil imports were 28% of total imports, engineering goods 18%, chemicals and related products 10%, gold and silver 7.6%, ores and minerals 6.8%.