The performance of India’s foreign trade in the current financial year points to the continued challenges posed by the external sector, despite the significant improvement in the balance on merchandise trade account. Data available till February 2015 show that merchandise trade deficit had reached a level from where it can show an improvement over the previous year’s $136 billion. This, therefore, would have maintained its declining trend since FY13, when the trade deficit had breached $190 billion.
As was the case in FY14, in the current year, the improvement in trade balance has come on the back of yet another round of moderation of imports, this time aided by the steep fall in crude oil prices. Import would have provided an additional degree of comfort had gold imports not increased by 12% during the 11 months this financial year after the removal of import curbs.
Export-growth has remained sluggish, as headwinds arising from continuing uncertainties in the global economy (that have now affected a number of emerging economies) have kept the markets subdued. Not surprisingly, several of the manufacturing industries, including electronics and textiles, have seen declines in exports, while most industries in the chemicals segment have shown indifferent performance.
However, despite the weak global cues, at least two of the larger manufacturing industries, namely, engineering goods and readymade garments, have performed phenomenally well in recent months. Under these circumstances, both the government and industry would have to address the twin challenges arising from the manner in which India’s manufacturing exports have performed. The first is to ensure that the export growth momentum does not remain restricted to only a few sectors, as has often been the case, and the second is to provide the necessary impetus to the dynamic sectors so that they can carry their strong performance into the medium-term.
At the same time, policymakers would have to work towards developing a comprehensive strategy to manage the trade sector. The critical element of this strategy would be to find ways to ensure that India’s external sector does not continue to remain dependent on the developments in the global economy and that autonomous impulses to trigger improvements in the merchandise trade account are put in place, especially by focusing on the competitiveness of India’s manufacturing.
It is somewhat surprising that despite the positive intent shown by successive governments to enable manufacturing enterprises operating in India to overcome their inherent lack of competitiveness, ground realities have hardly changed. The latest in this series of pronouncements, the Make-in-India initiative, has promised to change the face of manufacturing in India, but the roadmap for this seems to be still in the works.
There should be no doubt that the ability of the initiative to deliver on its promise would depend critically on the support that is provided to the backbone of India’s manufacturing, namely the small and medium sector, to compete in the global markets.
Providing an effective mechanism to address the issue of competitiveness has become even more imperative in view of the fact that the movement of the rupee has introduced yet another challenge lately. Until a year ago, the exchange rate movement seemed to favour India’s exports. The real effective exchange rate (REER) of the rupee, which RBI measures by using a basket of 6 currencies, shows that the currency had depreciated by over 9% between FY11 and FY14, which, some would argue, helped India’s exports to stay overboard in the immediate aftermath of the global downturn. But since FY14, the 6-currency REER has moved sharply in the opposite direction. In February 2015, REER showed an appreciation of the rupee by more than 10% as compared to the average for FY14. The 36-currency index showed a smaller appreciation, only a tad lower at 9%. There has always been a debate as to which of the two indices, namely the 6-currency or the 36-currency, gives a better indicator of the country’s currency value relative to the other major currencies. Many have argued that the 36-currency index is probably a better yardstick for it includes most countries that are directly competing in the markets that Indian exporters find themselves in. However, in the current phase there are enough reasons to consider the movements in 6-currency REER.
The primary reason is the inclusion of the Chinese yuan in the 6-currency basket, a currency that is witnessing an unprecedented appreciation over the past year. The yuan is loosely pegged to the US dollar and the steep appreciation of greenback (by almost 18% against most traded currencies) has meant that former has also appreciated in tandem. What is now being asked is whether the Chinese authorities would pull the plug and allow a depreciation of the yuan, and if they do walk this path, when would they be doing it. These questions have become relevant given that the state of the Chinese economy just doesn’t not justify the current strength of the yuan. One indicator has been the large capital outflows. In the fourth quarter of 2014, China recorded a deficit in its capital account of $91.2 billion, the largest that the country has registered in more than a decade. The People’s Bank of China had briefly intervened to shore up the value of the yuan using a small part of the country’s $4-trillion foreign exchange reserves.
China’s exports have also been performing poorly, and even though the figures for February show the largest increase registered in a single month since 2010, most observers maintain that this expansion cannot be sustained. They argue that if circumstances demand, the Chinese authorities would not hesitate to let the yuan depreciate. In other words, the small steps they have taken in the recent past to maintain the value of their currency may not be forthcoming.
What should be India’s strategy to counter these developments? Following its Article IV consultation with India, the IMF has recommended allowing for an orderly depreciation of the rupee, with judicious foreign exchange intervention. This recommendation needs to be weighed cautiously both for the consequences it could have on the external payments situation as well as the message such a step would convey to India’s trading partners.
The author is professor, Centre for Economic Studies and Planning, School of Social Sciences, JNU