India sees sharp decline in IT sector's ability to fund trade deficit

A relatively slower growth in IT Services exports has made India ever more dependent on capital inflows and workers remittances to fund its trade and the overall current account deficit

IT services are India's single biggest export and a key source of foreign exchange. But there has been a sharp decline in the IT industry’s ability to fund India’s fast-growing merchandise trade deficit and current account deficit.

The net export of IT services funded just 30 per cent of India's merchandise trade deficit in July, down sharply from 68 per cent in the year-ago period. 

In the past 10 years, the net export of IT services, on average, has funded 57.5 per cent of India's merchandise trade deficit.

The country’s net IT services export was $9 billion in July this year, up 20 per cent from $7.5 billion a year ago. In comparison, the merchandise trade deficit was up 173.4 per cent to $30 billion in July this year, from $11 billion a year ago.

Net export is gross export minus gross import. When the value of imports exceeds the value of exports, the country runs a trade deficit as has been the case with India's goods or merchandise trade.

The long-term trade is even more clear in the annualised or the trailing 12-month data. In the 12 months ended July this year, the net export of IT services amounted to $101.1 billion, up 9.9 per cent from $92 billion during the 12 months ended July 2021. During the same period, the merchandise trade deficit more than doubled to $258.7 billion in July this year, from $127 billion in July this year. As a result, the net IT export funded 39.1 per cent of India's trade deficit during the 12 months ended July 2022, down from 72.3 per cent a year ago.

Relatively slow growth in IT services exports has made India ever more dependent on capital inflows and worker remittances to fund its trade and the overall current account deficit (CAD). This translates into volatility in the external sector and puts pressure on the rupee.

“India’s deficit is growing faster than IT services exports and we are more reliant on capital inflows to fund the current account deficit than in recent years. This makes the economy vulnerable to the changes in global capital flows, as has been the case in the current calendar year,” says Dhananjay Sinha, head of strategy and research at Systematix Group.

The Indian rupee declined 7.2 per cent against the dollar in the first seven months of CY22 due to a wider current account deficit and the decline in foreign portfolio investments.

Others point to higher crude oil prices — India’s biggest import. “The terms of trade are likely to worsen overall. The effect of the oil price shock is likely to be exacerbated by the simultaneous rise in prices of coal, natural gas, edible oils, and gold,” write analysts at Emkay Global Financial Services.

The recent trend in foreign trade hints at a further decline in the IT sector’s ability to fund India's merchandise trade and current account deficits. There has been a sharp slowdown in goods or merchandise exports in FY23, while imports of IT services are now growing faster than their exports. The merchandise export was up 18.5 per cent YoY in the first four months of FY23, down from 41.7 per cent YoY growth in FY22. In comparison, the slowdown in merchandise import was much milder at 48.3 per cent YoY in April-July 2022, against 56.37 per cent YoY in FY22. As a result, the merchandise trade deficit jumped to $101 billion in April-July 2022, against $199.5 billion in the entire FY22.

Similarly, the import of IT services was up 46 per cent in April-July 2022, against 15.8 per cent YoY growth in FY22. In comparison, the export of IT services was up 27.8 per cent YoY in April-July 2022, against 15.3 per cent growth in FY22. As a result, the net export of IT services was up only 5.2 per cent in April-July this year versus 14.6 per cent in last financial year.