Financing India’s Twin Deficit

Faced with a slowing growth, stubborn inflation, deteriorating public finances and the risk of losing investor confidence the immediate priority of the ministry of finance is to get the economy on the back on the ascending growth trajectory and at the same time take measures to reduce the overall Government budget deficit from US$ 67.5 billion to a sustainable level and also narrow down the growing current account deficit from a worrying level of 5.5% of the nation’s GDP.

The government in its attempt to change the pessimistic narrative has announced a set of measures that deals with essential reforms to help grow the economy and is also focused on getting the country’s fiscal house in order. However, there are still a number obstacles holding the country back and the government will need to show that its reform AGENDA is a work in Progress and it is committed to seeing the process through. Most Indian corporates  remain optimistic about future business and growth prospect is improving as evident from various economic surveys and projections. The Indian economy is highly likely to grow at above 6% level during the next fiscal year and to deal with immediate macro issues the minister of finance Mr Chidambaram has been emphasising the need for the country to attract foreign investment as a way to fund its growing current account deficit.

Clearly one of the main objectives of the Budget announced last week is to pitch India as an attractive investment destination in order to ensure and encourage the inflows of foreign investments coming into the country. In his budget the finance minister has also tried to simplify the existing process for foreign investors to invest in rupee denominated securities. Also to attract foreign investments, Mr P Chidambaram plans to visit Japan, USA and Canada next month as a part of his roadshow to meet the global investors. Other measures in budget includes of reducing withholding tax on infrastructure bonds, facilitating currency risk hedging for foreign investors as well as encouraging the Indian companies sitting on a pile of cash to start investing in the real economy.

While all these measures are a step in the right direction there is clearly a need for the ministry and the policy makers to be always forward looking. They should take the opportunity to explore IDEAS that will help expand the reach of the existing financial infrastructure of the country. According to the Reserve Bank of India roughly around 40% of Indians have bank accounts also based on numerous studies done by NIPFP and Wanchoo committee the size of the informal and cash economy is estimated to be over 35% of India’s GDP. The estimated private Gold holdings in India is worth over US$ 975 billion based on current valuation. Also the combined wealth estimate of 30 million non resident Indians  ( NRIs ) spread across 140 countries is around US$ 1.22 trillion. India also benefits immensely from the largest remittance flows in the world. The total remittance for the year 2011- 2012 was US$ 66 billion and it is projected to exceed US$ 73 billion in 2013.

The government should make serious efforts to tap into these pockets of liquidity and work towards its better utilisation going forward keeping in mind that money has no nationality so it will have to compete for capital just like any other country. And with this in my mind I believe the policy makers in India should consider innovative yet simple ideas that will allow the country to create a sustainable long term solution and also an enlarged pool of capital participating in the real economy. The government should also be able to fund its twin deficit by better utilising and accessing the nation’s existing untapped financial resources if and when required.

There are a number of options worth exploring and one of them could be for the ministry of finance to consider issuing directly or indirectly through a specially created entity certificate of deposits denominated in US dollar managed by the Reserve Bank of India and arranged by Indian as well as overseas banks. To broaden the appeal these certificates could be linked to growth and could also have an added feature of  “privatisation exchangeable securities” in a pre-identified list of companies owned by the government of India. And listing these securities will create a liquid market for this product broadening the investors base further.

The other option worth exploring will be to encourage the development of tax free inflation gold linked certificate of deposits. Under this arrangement a list of approved and qualified banks could offer gold deposit certificates against the physical gold deposited by private individuals, religious organisation, various firms among others. These deposits could be held at the Reserve Bank of India for which the central bank could charge a nominal fee to cover  its  costs.  To broaden the products appeal the gold deposit certificates could also trade along the same line as a Gold ETF.

According to RBI Gold imports account for 80% of the current-account deficit of the country so a better utilisation of the private gold holdings in India will help lower the gold imports resulting in a lower current account deficit, a stronger rupee and obviously an improvement in the overall investors sentiment around India. It will also significantly improve the liquidity position of the financial markets in the country boosting investment, growth and employment.