4 reasons behind India's rocketing current account deficit

Forecast is 4.9% of GDP despite lower gold imports.

According to Nomura, it expects India's CAD to worsen to 4.9% of GDP in FY13, despite lower gold imports, due to weak exports, a lower invisibles balance and inelastic oil and other commodity imports.

But it noted that unlike FY12, gold is not responsible for the higher CAD. Net exports of gold moderated to USD14.6bn during Apr-Oct 2012 from USD30.6bn in the corresponding period last year. Yet, the trade and the current account deficit worsened during this period. Here are four responsible factors Nomura came up with:

1) Exports are losing steam: The slowdown in advanced economies lowered the demand for India's major manufactured exports which are demand sensitive and mainly consist of non-differentiable low-end metal products and other items like handicrafts, leather, gems and jewellery.

However, the slowdown was exacerbated by the clamp down on mining activity due to mining bans, which hurt exports of ore, minerals and other commodities. In addition, agricultural exports weakened after May due to a lower summer crop output in FY13 and the ban on cotton exports. In our view, weak global demand and rising labour costs offset the benefits from nominal currency depreciation.

2) High oil prices and inelastic demand for oil: India‟s net oil imports worsened to USD66.1bn in 2012 (Apr-Oct) from USD53.4bn during the corresponding period the prior year. Increasing dieselisation of the economy and high oil prices are leading to higher imports of crude oil.

Even though the economy grew at a meager 5.4% in H1 FY13, of which the industrial sector grew at a low 1% y-o-y, net crude oil imports (volume) grew at a faster pace of around 8% y-o-y.

This is primarily due to artificially suppressed diesel prices and the increased use of diesel-based electricity power generators (to compensate for the lack of a coal-based supply of power). Further, in order to meet ever-growing domestic demand, exports of refined petroleum products have slowed sharply.

3) A rising trade deficit in non-oil, non-gold segments: Excluding oil and gold, India‟s trade deficit worsened sharply to USD33.2bn in 2012 (Apr-Oct) from USD22.8bn last year.

As we highlighted in our special report on India’s chronic balance of payments, there has been a structural increase in import of essential commodities such as edible oils, coal and fertilizers due to severe domestic supply constraints: the mining ban (coal), low agricultural productivity (edible oil) and a lack of domestic resources (fertilizer). Since the demand for these items is inelastic to currency changes, INR depreciation has also contributed to increase in the value of the import bill.

Other miscellaneous imports‟ also rose sharply during May-Sep, but seem to have moderated again in recent months.

4) The cushion from invisibles has waned: The invisibles balances contracted by 1.4% y-o-y in first half of FY13 from growth of 13.8% last year due to slower growth in software services, a steeper outflow from non-software services (-USD3.7bn in H1 FY13 from -USD0.4bn in H1 FY12) and a sharp rise in investment income outflows (-USD10.5bn from -USD7.6bn) due to rising interest payments on foreign investments in India.