Current account deficit may touch 4.2% GDP in FY13: Nomura

The current account deficit may touch 4.2 percent of gross domestic product (GDP) in this fiscal as well, as upside risks to the external environment are rising for the economy, brokerage firm Nomura said today.

The brokerage had earlier forecast a tempered 3.8 percent current account deficit (CAD), the difference between country's total imports & transfers and total exports & outward transfers, for this fiscal, following steady fall in inward and outward shipments and the resultant narrowing of trade deficit in the first half of the fiscal.

In the past fiscal too CAD had hit a record of 4.2 percent of GDP. "With external situation remaining very worrying, we see more upside risks to our CAD projection of 3.8 percent with the current trends suggesting that it could be as high as 4.2 percent of GDP, which was recorded last fiscal," Nomura India economists Sonal Varma and Aman Mohunta said in a note.

However, they blamed the latest spike in imports due to the import substitution, saying, "the phenomenon of rising imports and lower domestic output can be explained by increasing import substitution as a result of supply-side constraints and elevated inflation."

The trade deficit widened to an all-time high of USD 21 billion in October from USD 18.1 billion in September due to weak exports, which declined for the sixth month in row to minus 1.6 percent y-o-y in October and and rising imports which rose 7.4 percent in the month.

What is worrying is the stronger imports which rose 7.4 percent against 5.1 percent a year ago, they said, adding "this is not consistent with an economy that is slowing sharply."

The trade deficit worsened by an average of USD 3.8 billion between September and October during the last three years. However, the trend in imports ex-gold is also clearly higher, they warned.

Explaining the rising upside risks to higher CAD, they said the problem is that the rise in non-oil imports is not consistent with a slowing economy, as the IIP data suggest. Also, the higher trade deficit reflects weak exports, driven by a seasonal rise in gold demand and also a genuine improvement in imports due to import substitution.

"The ongoing rebound in import suggests that supply-side constraints and the high cost of domestic production may be leading to greater import substitution, dragging on domestic industrial production and worsening the trade deficit, The rise in imports is not consistent with a slowing economy,"
they said.

The government and the Reserve Bank as also economists are of the view that the country can sustain a 3 percent CAD comfortably with the current level of capital inflows. Nomura, however, downplayed latest contraction in IIP saying the negative industrial output data may be exaggerating the growth slowdown, as power outages have also constrained production.

"Overall, the data suggest that the economy is facing severe supply-side constraints, making it imperative to ease bottlenecks. Until then, we expect recovery to remain shallow as the economy will be quick to hit a ceiling," Nomura said.

Factory output contracted by 0.4 percent in September, even as CPI inflation remained sticky and non-oil driven spike in imports pushing up the trade deficit to a record high since 1994. "While firms usually build inventory pre-festival seasons, we believe that power outages may have constrained production this year, resulting in firms drawing down on inventory to meet demand.

"This trend likely continued in October as the stock of finished goods index. In addition, consumer non-durables output growth moderated sharply reflecting lower summer crop production," Nomura said.

Stating that growth is bottoming-out, and not falling, it said growth in the intermediate goods output, a precursor to final demand, remains positive and, on a three-month moving average basis, IIP growth was 0.5 percent y-o-y in September from a trough of minus 0.7 percent in May.

Also, excise mop-up accelerated by 17.5 percent in September from 0.3 percent in April. Similarly, import growth, excluding oil and gold, is also trending higher. "Therefore, we believe that the IIP data may be overestimating the growth slowdown. More likely, we believe that the industrial cycle is bottoming-out. Unlike the past, we expect a longer period of consolidation in this cycle due to weak exports, lacklustre investments and moderating consumption demand."

It also blamed the government's wheat procurement programme saying it has created an artificial scarcity in the market pushing up prices, while pulses prices have risen due to lower output.