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Wednesday 30 May 2012

The real reason behind India's current account deficit

This post is for those of my friends who believe that the stock market is a plaything of the rich and bored and it has no real significance in the real economic progress of India.

The last few months India has seen a free-fall of the rupee with respect to the dollar. From Rs 45 it has gone to Rs 56 in a matter of months. The steep Rs. 7.5 hike in petrol prices has been attributed to this fall in rupee. During this period, crude oil, the other component of petrol price, has come down from $125 to about $105.

So why is the rupee falling like nine pins?
The answer to that question lies in India's current account deficit. To understand in simple terms what the current account deficit means, lets look at its constituents. Roughly, Current A/C (CA) = Balance of Trade (BoT) + FDI flows + FII flows + Remittances. Out of this BoT is  the difference between export and import. 

Whenever there is a change in price, it means there is a change in the demand-supply situation. Similarly, if rupee is falling, it means, dollars are more in demand than Rupee. Exporters sell their products and earn in dollars and they convert them to Rupees. And importers buy  these dollars with Rupees. Currently, importers are buying more dollars than exporters selling rupees. That is one main reason why the rupee keeps falling.

Then why did the Rupee appreciate (go up) during Jan-Feb this year?
Now, we come to the interesting part. India has been historically a trade deficit (negative BoT) country because we have to import oil. We also import a lot of gold and increase in taxes & duties on gold by the FM this year was to in some ways to prevent the outflow of dollars. So, what changed earlier this year? Or what held the rupee to around Rs 45 for such a long time? The joker in the pack is FII inflows. India has been making up for its BoT deficit by primarily FII inflows into the stock market and to some extent through remittances from expats abroad. If you look at remittances, RBI has increased NRI deposit rates to attract this, but without much success. That leaves us with FII inflows. If you track net FII inflows, you will see a marked correlation with the dollar-rupee conversion rates. With the ineffective policy making, GAAR, scams and trouble in the Euro zone, the FIIs are spooked. They are taking away money from the Indian markets and leading the pressure on the Rupee. 

So, to my sceptic friends, the stock market does impact you, whether you invest or not, in more ways than you can imagine!

It is unfortunate that such a large country has to be dependent on FIIs for its economic well-being, but that is the way it is. It is likely to remain that way till we can make such policies which increase our exports.

1 comment:

  1. I have been trying to know why the dollar rate is rising and why is the rupee value falling? When will all these get over and India will have a better economy? Please share your ideas with me if you are aware of it.