Mildly encouraging

The sharply narrowing merchandise trade deficit to $6.7 billion in September has lowered the share of current account deficit (CAD) in the GDP—promising enough for a defensive UPA government to flay IMF’s GDP projections for fiscal 2014. However, the over $20 billion trade deficit reduction in July-September as compared to the preceding April-June quarter would raise questions if this positive trend is indeed sustainable. While consumption has been maintained on an even keel, resulting in the trade deficit being narrowed to reasonable proportions for the first time in 30 months, it is also important to maintain that the fall in gold imports could be as much a function of excise duty being increased to 10 per cent – as it is of the underground economy taking over.

Going by the more negative responses to the September trade deficit numbers, gold imports via the underground economy could be much higher than anticipated, and not on the current account, which RBI governor Raghuram Rajan is looking to tether ‘imminently’ at around $70 billion. Yet, there are grounds for Rajan to be confident, as a lower CAD will help ease the apex bank’s constraints on rupee-related concerns, and help reduce exchange-rate led inflation pressures. This can also help reduce expectations on more repo rate hikes. However, the supreme challenge of consistently moderating high CAD cannot be taken for granted when the question remains as to how sustainable the September trade deficit numbers are.

How the trade deficit is financed going forward will be crucial. The festive season looms ahead, and gold imports are bound to regain momentum, boosting non-oil imports as well. Not to mention rebounding demand for oil, coal and iron ore. The trade gap is likely to look less rosy then. The above factors, coupled with higher inflationary expectations going forward must be countervailed by pushing liquidity management measures consistently and further reduce pressure on the rupee. Capital inflows have been improving since late August through the banking counters and the rupee is indubitably on firmer ground. But once the OMCs actively return to market and oil importation in right earnest, the real test of the rupee’s stability (and trade deficit sustainability) will begin. For now, take the trade data with a pinch of salt – at least, till the corporate earnings and fiscal deficit numbers for April-September come in.