Growth-oriented Budget can worsen trade deficit

The Budget intends to stimulate growth by boosting capital expenditure and driving domestic consumption in the given context of tepid export growth prospects. The hope is that increased domestic demand will spur higher utilisation of capacity by private enterprises and lead them to investments in fresh capacities. In theory, this strategy is sound but increased imports can spoil the plans.

The Indian economy is a ‘bright star’ growing at about 7 per cent, the fastest rate among major economies. Our imports are likely to grow faster than exports widening the trade deficit. The Economic Survey recognises this possibility and says that robust growth in export of services and buoyant inward remittances will help narrow the current account deficit and that the foreign exchange reserves are adequate to cushion against any shocks.

The Budget envisages the capital expenditure to go mainly towards building infrastructure, especially in the transport sector. The productivity gains of such long gestation projects can take time to play out but in the meantime the money pumped into such projects can find its way into the hands of people. Their spending of the additional money will boost demand further putting upward pressure on the prices. That can induce higher supplies through better utilisation of idle capacities of the domestic producers. However, imports may rush in and compete to meet the spurt in domestic demand, weakening the Indian rupee.  

The global scene is that except for East Asia and the Middle-East, the rest of the world is slowing down. The rebound of the Chinese economy is likely to push up demand for commodities whereas the slowdown in Europe and America is likely to bring down the demand for finished products. So, the chances of commodity prices going up while the prices of finished products going down cannot be ruled out. If that happens, the domestic industry is likely to face intense competition from imports for meeting growing domestic demand for finished goods. The resultant rise in import volumes and the higher commodity prices may push up the trade deficit significantly.

Higher inflation, higher wages and tight labour market conditions in advanced economies are forcing many companies abroad to outsource their software requirements from India. So, the prospect of strong growth in export of services is better than a few months earlier. Still, the net earnings from export of services may not be enough to fully offset the merchandise trade deficit.

The Central Banks in developed countries seem more determined to bring down inflation even at the cost of growth whereas Reserve Bank of India seems more intent on sustaining growth even if the inflation rate is at the upper end of its target. So, a higher interest rate regime looks more likely in the developed countries causing outflow of funds in search of safety and better returns, putting pressure on the rupee.  

Hopes abound that foreign direct investments and foreign portfolio investments will find India an attractive destination to offset any surge in current account deficit. If the perceptions of robust regulatory and corporate governance standards in the country persist, such inflows can arrest rupee depreciation, helping imports keep our domestic producers at the same levels of capacity utilisation.  

So, it is far from certain that massive public expenditure will necessarily crowd in private investment. Yet, the government deserves appreciation for its growth-oriented Budget.  

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