January trade deficit highest in almost five years
Commerce minister Suresh Prabhu has his work cut out. While he has said, recently, that the government will soon come up with a strategy to increase the share of exports in GDP to 40% by 2025, up from 18% right now, export growth has been falling for the last two months. And, at $16.3 billion, the January trade deficit is the highest in almost five years and significantly above the $13.4 billion average in April-December 2017. Not surprisingly, most brokerages have raised their current account deficit (CAD) estimates for both FY18 and FY19 to around 2% of GDP. This is not high enough for India to be worrying about a twin deficit problem—the fiscal deficit will be further hit by the MSP-based deficiency payment system proposed in the budget—but it is certainly time to be watchful since trouble can creep up quite rapidly.
The last time India had a CAD problem was in FY12 and FY13 when CAD was 4.3% of GDP and 4.8%, respectively. Ever since then, the CAD had been falling, to 1.7% of GDP in FY14, 1.3% in FY15, 1.1% in FY16 and 0.7% in FY17. And then, suddenly, this trend has been reversed and the CAD is likely to be around 2% in FY18. Should oil prices rise further, the likelihood of a higher CAD can’t be ruled out. The real problem stems from the fact that three sectors—gems & jewellery, textiles and pharmaceuticals—that comprise around a third of all exports are barely growing. In FY17, they grew by a mere 4.3% and in the first nine months of FY18, they have barely grown, to $69.8 billion over $69.7 billion in the same period of FY17. The problem of GST refunds is a serious one—the commerce secretary brought it up at a meeting of the cabinet secretary a few days ago—despite all the assurances given by the finance ministry.
Another problem, and likely to be more deep-seated is that all three sectors have a large presence of informal units and are, therefore, more likely to have been badly hit by both demonetisation as well as GST. Since profit margins are also very thin in these sectors, the strong rupee is also likely to have hit them. To some extent, the 24% growth in non-gold non-oil imports in January is also reflective of the fact that the demonetisation and GST impact on the supply chain continues. As a result, this is the first time since FY15 that the economy is more vulnerable to forex flows. In FY15, the basic balance of payments (CAD + net FDI) was positive after several years—while the CAD was $26.8 billion, net FDI was $31.3 billion. In FY8, in contrast, while the CAD is estimated at $51.8 billion by Citi Research, net FDI is likely to be a much smaller $37.2 billion. This makes the rupee very volatile to every outflow of FPI funds, more likely now with US interest rates rising. Sooner rather than later, the government needs to address the issue of uncompetitive export industries, and that includes serious labour reforms. Till then, India’s exports growth will always be touch and go.