Trade imbalance

External sector needs careful management

Policy intervention would be required at different levels to contain the fallout of increasing global uncertainty. Central banks in advanced economies are forced to sharply increase interest rates and tighten financial conditions to contain inflation, even as economic recovery from the pandemic-induced disruption is weakening. Slower global growth, as a result, will affect exports from a developing economy like India, while tightening financial conditions would influence capital flows. In this context, the latest trade data underscores that the external sector will need careful management. India’s merchandise trade deficit increased to a fresh high of $31.02 billion in July compared to $26.18 billion in June. The trade deficit was $10.63 billion in July 2021. While exports declined marginally compared to the same period last year, imports went up by 43.59 per cent. The trade deficit for April-July crossed $100 billion compared to about $42 billion during the same period last year.

On the export front, while electronic goods and rice showed robust growth, shipment of engineering goods and petroleum products declined. Petroleum products seem to have suffered because of the imposition of export duty. Meanwhile, imports remained stickier. Import of petroleum products increased by over 70 per cent. Analysts expect imports to soften in the coming months, partly because of the decline in global commodity prices, though energy prices are still elevated. The import of coal should also moderate as the government has revoked the order on mandatory blending of imported coal following improvements in domestic supply. However, at the aggregate level, the deficit is likely to remain elevated. Exports would suffer because of weak global demand conditions, while imports remain at higher levels owing to higher energy prices and the ongoing recovery in the Indian economy.

Economists expect the current account deficit (CAD) to be over 3 per cent of gross domestic product in the current fiscal year. While the level of CAD is not particularly alarming, uncertainty on the capital account could create difficulties. Although foreign portfolio investors have returned to Indian markets in recent days after selling assets worth over $30 billion this year, capital flows would remain under pressure because of the given global economic and financial condition. The external condition also suggests that the recent appreciation of the rupee against the US dollar could be short-lived. Further depreciation will help contain the CAD by pushing exports and compressing imports. It will also make Indian assets more attractive for foreign investors, encouraging capital inflows. It is worth noting here that the dollar index has gone up by about 11 per cent this year, which has put enormous pressure on a number of currencies, including the euro and yen.

The relative strength of the rupee could affect India’s external competitiveness and exacerbate the imbalance. The Reserve Bank of India has been intervening in the market aggressively to contain excess volatility and the decline in the rupee. It would do well to reduce intervention and allow the rupee to depreciate, which will make external account management relatively easier. While a weaker currency can push up inflation, normalisation of monetary policy and liquidity conditions would help anchor expectations. At the broader level, while the government is hopeful of attaining the export target of $500 billion in the current year, India needs a more pragmatic trade policy to push up exports sustainably, which will not only provide durable external stability but also increase overall economic growth.