Editorial✍ Financial Express Prelims cum Mains

Rapid deterioration in India’s external sector

Deteriorating external sector

Trade deficit:

  • The trade deficit for July hit a five year high of $18 billion.
  • This, coming on the back of a $17.1 billion deficit in June, indicates that India’s external sector is deteriorating fast.

Exports not picking up:

  • The bad news is that exports are not really picking up despite GST-related problems having been more or less sorted out.
  • The growth in non-oil exports moderated in July to 11.9% y-o-y (from 13.4% y-o-y in June); overall exports rose 14.3%, but on a very weak base of 3.9% in July, 2017.
  • Agriculture, engineering, pharmaceuticals, textiles and leather haven’t done as well as expected though overall volumes are seen to have picked up.

Growth in imports:

  • Imports, on the other hand, jumped 29% y-o-y, led by bigger pre-festive season purchases of gold and electronics as also coal and chemicals.
  • Monthly oil deficits are now at levels seen in 2013.

 

Currency depreciation:

  • The currency has been depreciating—the rupee has lost some 8% since January.
  • Cheaper rupee alone can’t boost exports:
    • Not only rupee, almost all competing currencies have lost value and several of them have fallen much more than the rupee has.
    • As a result, a weaker currency can’t really make a big difference to exporters’ ability to price their products competitively.
    • Even otherwise, the currency plays a much smaller role in boosting exports and it is other factors, such as poor infrastructure, high relative wages and rigid labour laws that are the bigger obstacles.
  • Could potentially lead to reduced imports:
    • A weaker rupee could rein in imports as they get costlier.
    • Moreover, since there is no evidence of meaningful capital expenditure and the economic recovery isn’t really fast-paced, imports of plant and machinery could moderate as could the demand for gold (once the festive and wedding season demand drops).

 

Higher Current Account Deficit:

  • Last year, the current account deficit (CAD), at $48.7 billion, was a little under 2% of GDP.
  • Economists estimate the CAD for 2018-19 could come in at around 2.7% of GDP on the back of a near $200 billion merchandise deficit.
  • The basic BoP—current account plus net FDI—is also estimated to be negative.

Total capital inflows could be lower:

  • Capital flows this year are unlikely to be as strong as they were last year.
  • FDI to increase:
    • Foreign direct investment (FDI) flows are estimated to be higher by just about 10% this year over last year’s $30.3 billion.
  • But FPI could drop:
    • In 2017-18, these were a reasonably strong $22 billion with most of the portfolio flows (Foreign Portfolio Investment or FPI) flowing into the bond market.
    • However, between April and mid-August, foreign portfolio investors have pulled out $5.6 billion from the bond markets and $2.32 billion from the equity markets.
    • There is still possibility of a recovery, with trends showing money has moved into the bond market in August.
    • Nonetheless, given interest rates are rising in the US and the risk aversion to emerging markets (EM) remains, flows could stay modest.

So capital flows may not be enough to fund CAD:

  • Usually the high capital flows (through foreign investment) takes care of the current account deficit (CAD).
  • But the lower capital inflows may not be enough to fund the CAD.
  • However, RBI holds adequate reserves of $400 billion plus, and so there is no reason to panic.

 

Way ahead – interest rates could rise:

  • The sharp fall in the currency over the past few days (it recently hit a new low lifetime of 70.30), and the fact that RBI’s inflation forecast for Q1FY20 is well above its target, suggests interest rates could be raised again.

 

Importance:

GS Paper III: Indian Economy

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