Widening trade deficit may dent India's growth

As India's rebounding economy raises demand for manufacturing and oil imports, trade deficit is bound to rise, but the euro zone debt crisis hitting country’s exports and economic and political upheavals in oil producing nations have sent the deficit soaring manifold and much beyond expectations.

India’s trade deficit was close to $132 billion last year and is expected to go up to $160 billion in 2011-12, according to official estimates, but unofficial figures are much higher. Experts are concerned that if the trend continues, the country may close the current fiscal with a trade deficit of nearly $175 billion.

The mounting oil import bill has made India’s oil bill jump over 80 per cent this year, leading to the northwardly movement of trade gap.

India imports close to 80 per cent of its oil requirements and with the consumption levels rising, imports are only expected to soar. Not only the oil imports, but the non-oil imports have also risen in the past.

However, exports have not kept pace. Waning demand for India’s engineering and petroleum products in Europe has put a serious dent on country’s exports in the past many months, but the imports in the same period have continued to rise, putting undue pressure on trade gap.

In more recent times, there has been sluggish agricultural sector exports caused by a ban on non-basmati rice exports and restrictions on cotton exports, but there has been no breaks on imports at the same time, increasing the gap further.

Although the government has tried to take shelter by saying that trade deficit is not because of the want of efforts but due to global economic situation, the fact that the deficit has put pressure on rupee and made many of the much needed imports dearer, has sent jitters down the nerves of investors and India Inc.

“Soaring trade gap is certainly a concern. Expensive imports are putting pressure on industry and worries are compounded with depreciating rupee in the past,” says Ficci President Rajiv Kumar.

Trade deficit & the rupee

Whenever trade deficit occurs, it means that the currency of a nation is depreciating, due to more imports of goods and services than exported. This was quite evident in India’s case when its currency late last year depreciated close to 16 per cent from a peak of 44.18 in 2010.

The ballooning trade deficit has other ramifications too as it may throw the current account deficit out of gear. The trade ministry has raised serious concern as India’s trade deficit is set to balloon to $278.5 billion by 2014, a twenty-fold increase over a decade from the $14.3 billion in 2004.

A large widening of the trade deficit can potentially result in balance of payments difficulties, and it is not acceptable beyond a point as it may jeopardise the entire growth process of an already slowing economy. But, trade deficit for India is not a new phenomenon. In 2009-2010, India had the world's third largest merchandise trade deficit, at $107 billion, behind only the US $ 691 billion and the UK $154 billion.

Prior to that, in the 1980s, and 90s, too India experienced a chronic trade deficits. A close examination of trends reveals that India’s merchandise trade has always experienced a deficit, but this has been offset by net earnings from software, remittance transfers, tourism and other invisibles.

But, this year the situation has become more precarious as there has been a widening of current account deficit too. To fuel the fire, the foreign inflows have dried up.

During April-September, the CAD stood at $32.7 billion, working out to almost 3.6 per cent of GDP. That makes it worse than even the 3 per cent level in the crisis year of 1990-91. The only difference is that the Reserve Bank of India's foreign exchange reserves of over $300 billion as of now are better than that of 1991 as they suffice to cover some eight months of imports.

Experts are of the view that India must work hard on improving the policy environment in order to attract more capital inflows, which dried up a major part of last year. “Policy and infrastructure hurdles pose greater problem in India for investors. Small quick fixes can make much of a difference and investor can start thinking of domestic manufacturing options rather than import,” says Economist of Yes Bank, Ahana Sahay.

But India’s infrastructure development has not kept pace with the demands of its manufacturing. Power is in short supply, highways are clogged with traffic and ports are too crowded. According to a recent study, the average cost to move a container within India is $945, more than double the $460 it costs in China.

Experts said, along with reducing dependence imports, government should vigorously look for newer markets for Indian goods and services. Under the new and focused market scheme, the government has searched markets in Africa and Latin America, but according to the traders body, Federation of India’s Exporters Organisation (FIEO), trade with these markets has not kept pace.

FIEO suspects, India may not be able to reach the target of $300 billion exports this fiscal and is also likely to miss doubling its overseas shipment target in the next couple of years, while the imports will keep rising, exerting pressure on trade deficit. India, one of the world’s fast-growing economies, exported a record $246 billion worth of goods in fiscal  2010-11, and has set an export target of $450 billion by fiscal 2013-14.

This, however, looks very bleak unless the goals of investment-led growth policies are followed vigorously in the forthcoming budget, economists say.

“Investment led economic policies will propel growth, reduce dependence on imports and help increase exports, thus reducing trade deficit and current account gaps,” Industry chamber CII says.