An effective way to ensure sustainability of India?s imports is to link their domestic prices to their international prices
In recent months, while both capital inflows into the country have fallen and India?s payments to the rest of the world have increased, the latter appears to have played a bigger role in the rupee?s depreciation. The current account deficit (CAD) in January-March 2012 was 4.5% of the GDP, the highest ever in the last several years. Insufficient capital flows to fund the CAD, is leading to the depreciation of the currency.
The RBI?s statement on 29th June noted ?in 2011-12, the CAD rose to $78.2 billion (4.2% of GDP) from $46.0 billion (2.7% of GDP) in 2010-11, largely reflecting higher trade deficit on account of subdued external demand and relatively inelastic imports of POL and gold & silver.? Imports of oil and precious metals contributed nearly 45% to the import bill during 2011-12. In this article, we examine the role of oil and gold in India?s imports. While the import bill of both these commodities has increased in recent months, the quantity of imports has increased for oil and petroleum products, and reduced for gold.
What is the reason for this disparity and what are the lessons from it? With almost 32% share in India?s merchandise import bill for 2011-12, oil is the single largest constituent of India?s imports. During 2011-12, India imported 187 billion metric tonnes of oil, worth $151 billion. The prices of crude oil (Indian basket) increased by 31.2% in 2011-12 as compared to 21.9% a year earlier. Despite such a steep increase in prices, demand for oil did not decline. In fact, quantity of imports of oil and oil products grew by 3.3% during 2011-12 and 4.1% during 2010-11.
With GDP growth slowing down and quantity of imported oil remaining relatively firm, India will have to resort to more efficient use of oil and oil products and also look at alternative fuels. And for this to happen, price elasticity of oil demand?sensitivity of demand for oil to changes in price?needs to rise. With highly subsidised fuel products in India, domestic retail prices do not keep pace with rising international oil prices, with the exception of a few fuels such as Naphtha and more recently petrol. This reluctance to pass on the increase in global crude prices to domestic retail prices lends buoyancy to domestic demand and puts pressure on the trade deficit.
All oil imports are not used for domestic consumption in India and a part is re-exported after refining the imported crude oil. In fact, India is now the largest petroleum products exporter in Asia, having surpassed South Korea in 2009. Given the fast-paced increase in exports of petroleum products, it is more apt to use net imports of oil and petroleum products (after deducting exports), while analysing the import requirement of oil for the domestic economy. The net import intensity of GDP (defined as number of imported units of oil and petroleum products required to produce Rs 1 crore worth of real GDP) has declined from 32 metric tonnes in 2000-01 to 24.3 metric tonnes in 2011-12. While this is a much desired trend, its pace needs to be accelerated to rein in the oil import bill.
While domestic retail prices need to be aligned to international prices in the case of oil, this is already the case for gold, the second largest import item. And the outcome is for all to see. Data from the World Gold Council shows that quantity of retail gold consumption has been falling in recent months. Indian consumers reduced their gold purchases to nearly 933 tonnes in 2011 from 1,006 tonnes in 2010. The value of imports surged during this period only due to rising prices. In the first quarter of 2012, both jewellery and investment demand (bars and coins) slipped further as gold price continued to remain robust?retail jewellery fell to 152 tonnes in the first quarter of 2012 from nearly 188 tonnes a year earlier. During the same period, investment demand for gold fell to 53 tonnes from 103 tonnes.
This analysis points to a simple conclusion?the only effective way to ensure sustainability of India?s imports is to rationalise the demand for India?s major import items by linking their domestic prices to their international prices. While the ongoing decline in international oil prices can result in India?s oil import bill to come down somewhat this year, India would continue to remain vulnerable to future oil price shocks, unless domestic prices reflect international prices.
The authors are principal economist and economic analyst at Crisil