Record India Deficit May Limit Rate Cuts as Rupee Drops

India’s record current-account deficit threatens to weigh on the rupee and curb the magnitude of interest-rate cuts forecast to begin this month in support of government policies seeking faster growth.

The shortfall swelled to $22.31 billion in the quarter ended Sept. 30, the widest in Reserve Bank of India data beginning 1949. The rupee is down 6.1 percent against the dollar in the past three months, fanning price gains that will limit Governor Duvvuri Subbarao to a 25 basis-point rate cut on Jan. 29, according to eight of 10 analysts in a Bloomberg News survey.

India has the biggest deficit among the largest emerging markets, stoked by the worst export slump since the 2009 global recession and gold imports that Finance Minister Palaniappan Chidambaram said are a “huge drain.” Trade and budget gaps have increased economic risks, the Reserve Bank said Dec. 28, even as the government tries to lure more foreign investment and limit subsidies as Asia’s No. 3 economy struggles.

“The widening current-account deficit indicates very severe macroeconomic threats,” said Rupa Rege Nitsure, an economist at Bank of Baroda in Mumbai. “The central bank has less room to ease policy meaningfully.”

Subbarao has left borrowing costs at 8 percent since a 50 basis-point cut in April 2012, resisting Chidambaram’s calls in October for a further reduction.

Still, the central bank signaled in a statement of the Dec. 18 policy review that it may ease in 2013 as an inflation rate exceeding 7 percent cools. Two analysts in the Bloomberg survey predicted a 0.5 percentage-point cut in January.

Export Slide

The rupee weakened 1.1 percent, the most in two months, to 55.075 per dollar at the 5 p.m. close in Mumbai. The BSE India Sensitive Index climbed 0.1 percent. Five-year interest rate swaps advanced to 7.16 percent, the highest in more than a week, while the one-year rate rose as high as 7.6 percent, indicating investors pared bets on the extent of cuts in borrowing costs.

The deficit in the current account, which tracks goods, services and investment income, reached 5.4 percent of gross domestic product in July-to-September from 3.9 percent in the previous quarter.

Exports slid for seven months through November. Gold imports accounted for more than two-thirds of the current-account gap on average in the last three years, the central bank said in its Financial Stability report last month. India also purchases about 80 percent of its crude oil from overseas.

Rupee Outlook

The rupee will weaken about 7 percent to 59 per dollar by year-end, according to Nomura Holdings Inc. Kotak Mahindra Bank Ltd. predicts a drop to as low as 57 per dollar this quarter.

Prime Minister Manmohan Singh curbed fuel subsidies in September and opened industries including retail to more foreign investment, seeking to steady the currency, revive growth and avert a credit-rating downgrade that may disrupt capital inflows.

The current-account deficit may narrow as 2013 progresses, which, along with an acceleration in the economy, could “give the central bank room to ease policy” later in the year, said Sujan Hajra, a Mumbai-based economist at Anand Rathi Financial Services Ltd.

The nation may raise taxes on gold imports to tackle the shortfall, Chidambaram said two days ago as he called on citizens to curb demand for the metal. He is due to deliver the annual budget in February.

Remaining Vulnerable

For now, the rupee “will remain vulnerable” and the central bank’s “scope for aggressive easing is rather limited,” said Indranil Pan, an economist at Kotak Mahindra Bank Ltd. in Mumbai.

The Finance Ministry predicts GDP growth of as little as 5.7 percent in the year to March 31, the least in a decade.

The Jan. 29 policy review is set to be the first with Urjit Patel as an RBI deputy governor. Banking Secretary D.K. Mittal said yesterday Patel has been appointed pending final checks.

A report today showed India’s service industries expanded at a faster pace in December. The purchasing managers’ index rose to 55.6 from 52.1 in November, HSBC Holdings Plc and Markit Economics said in a statement.

China’s services activity slowed in December, while Australia’s contracted for the 11th month, reports today showed. Elsewhere in Asia, Philippine inflation accelerated last month.

European services and factory output contracted more than initially estimated in December, adding to signs a recession in the region may extend into this year. Consumer prices in the euro area increased more than economists expected in December.

In the U.S., non-farm payrolls probably rose by 153,000 in December after a 146,000 gain in November while the unemployment rate held at 7.7 percent, according to Bloomberg surveys. Factory orders probably climbed in November. An index may indicate non-manufacturing output expanded at a slower pace last month.

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