Import-intensity of India?s exports has been going up, which has been putting pressure on the current account

Finally, the Reserve Bank of India (RBI) has some good news on the country?s external sector. The year 2012-13 ended with a current account deficit (CAD) a touch below 5% of GDP, a vast improvement over the 6.7% that was recorded at the end of the third quarter. Although the magnitude of the CAD had remained alarmingly high, and almost three-quarters of 1% higher than that recorded in the immediately preceding financial year, the government would feel that the improvement in the CAD in the January-March period gives it a whiff of opportunity to get things in place.

The improvement in the CAD comes on the back of a strong performance on the export front as has been reported by the Department of Commerce (DoC). During the January-March 2013 period, exports surged by almost 10% as compared to the corresponding period in the previous year. In contrast, the immediately preceding quarter experienced a decline in exports. The export surge in the fourth quarter resulted in a decline in the trade deficit by nearly 5%. However, in the first two months, export growth has stuttered yet again, with the month of May registering a decline in exports in comparison with the same month last year. As a result, trade deficit in the new fiscal is already up by over 22% compared to 2012-13.

Exports are clearly emerging as an area of concern for the Indian economy. This concern arises further in a phase when the rupee has weakened. Economists will tell us that depreciation of the domestic currency should make domestically produced products cheaper and should hence result in increase in exports from the country. By the same logic, imports should decrease since they would lose competitive edge vis-a-vis domestic products. However, during 2012-13, exports declined by nearly 2% even as the rupee had depreciated by nearly 8%, while imports have increased by less than 0.5%. It may be mentioned here that there is a slight discrepancy between the trade statistics presented by the DoC and those presented by RBI. The latter reports a decline in exports by 1% and an increase in imports by 2%, which highlight the perverse relationship between exchange rates and trade performance in India?s case.

There are a number of reasons for this perverse relationship. The first is that bulk of India?s imports includes products whose domestic demand has risen consistently and for which domestic substitutes are not available. In 2012-13, three product groups?petroleum oils, gold and diamonds?accounted for almost 46% of India?s imports. Interestingly, these product groups have also contributed to exports; more than a third of India?s exports consist of petroleum products, and gems and jewellery. The third largest product group in India?s export basket?medicines, which contributed close to $12 billion in 2012?has also shown an increase in import dependence. Active pharmaceutical ingredients (APIs), which are needed to produce more of the finished formulations, accounted for more than two-thirds of the pharma imports. Once a net exporter of APIs, India has seen a five-fold increase in imports of these products in the past decade, with China emerging as a major supplier. Quite clearly, import intensity of India?s exports has been going up, which has been putting pressure on the current account.

Until now, the government?s strategy to check the CAD from spiralling out of control has centred on the mechanisms to curb gold imports. Recently, finance minster P Chidambaram appealed to the consumers to desist from buying gold for a year and to invest in other financial instruments. As of now, the odds seemed to be stacked against him, for gold has emerged as an asset-class whose returns over the past decade far exceeded those of all other forms of assets. It was, therefore, hardly surprising that the Indian investors would be expressing their preference for the yellow metal in this exaggerated manner.

Attempts to curb imports of gold through imposition of additional duties have more often than not resulted in increase in smuggling, thus nullifying the intended benefits. The imposition of additional duties last month has already witnessed increased inflow through illegal channels. The futility of import curbs can possibly be explained by the steep increase in India?s reliance on global markets for satisfying its growing domestic demand. According to the latest available figures, India was the largest importer of gold, a position that it has held from 2003. During this period, its share has gone up from 13% in 2005 to nearly 29% in 2011. In the dominant sub-category of gold?unwrought forms of gold?India has had a more dominant position; in 2010, it had a share in excess of 36% of total global imports. It can thus be argued that gold imports are structurally linked to various sectors of the economy; in particular, the financial sector and, therefore, the policy intervention by the government to limit its demand should go beyond mere tinkering with the import regime.

In the early years of the previous decade, inflows on the so-called ?invisibles? account was able to not only moderate the rising imbalance on the merchandise trade account but, in a few years, these flows enabled the country to register modest current account surpluses. This influence of the invisibles, which capture the balance on services trade account as well as remittances from abroad, no longer remains what it used to be. Slowdown in the global economy has adversely affected India?s services exports as well as remittances. While services exports had increased by nearly 7% in 2011-12, the growth rate was reduced to less than one-half last fiscal. More importantly, net exports of services, which had increased by more than 31% in 2011-12, faced virtual stagnation a year later.

Two other areas of concern in India?s current account are primary and secondary incomes. The former comprises mainly of compensation of employees, investment income and other primary receipts, while the latter largely comprises of private transfers. Primary income showed net outflows of $21.5 billion during 2012-13 as compared to $16 billion a year earlier mainly on account of larger outflow under investment income. Outflows on this account rose by 21.2% to $28.8 billion in 2012-13 from $23.7 billion in 2011-12, which was largely reflective of the sizeable increase in interest payments on growing foreign debt. In the past five years, the country?s total external debt increased by more than 70%, with short term having doubled. Financing liabilities of the growing current account was thus beginning to tell.

The increase in the CAD clearly reflects some weaknesses in the Indian economy that the government and the business interests must address urgently. Many of these weaknesses have become structural in nature, which require medium-term perspectives to overcome them. The first among the many areas that need attention is the lack of dynamism in the export sector. Careful consideration should, therefore, be given to the development of an export-oriented industrial strategy that leverages the vast potential of the diversified industrial base existing in the country. This, in our view, should be the focus of the manufacturing strategy that the government has been working on for some years.

Past experience shows that India?s exports of goods and services need to be diversified both in terms of the sectoral composition and their destinations. Thus, there is a need to reduce the high dependence of the services sector on information technology and the enabled services by exploring export opportunities in other areas of competence, including education and medical services. At the same time, there is an urgent need to turn away from the inordinately large focus on markets in the advanced countries, which are not likely to offer additional market access in the near term, given their continuing economic uncertainties.

The author is director general, Research and Information System for Developing Countries, New Delhi